Exam 12: Estimating Cash Flows on Capital Budgeting Projects

ABC Engineering just bought a new machine. All of the following are examples of incremental cash flows EXCEPT:

Your company is considering the purchase of a new machine. The original cost of the old machine was $25,000; it is now five years old, and it has a current market value of $10,000. 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 $12,500 and an annual depreciation expense of $2,500. The old machine can be used for six 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 $20,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $3,500 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life, and the cost of capital is 13 percent. Assume a 40 percent tax rate. What will the year 1 operating cash flow for this project be?

You are trying to pick the least expensive car for your new delivery service. You have two choices: the Scion xA, which will cost $15,000 to purchase and which will have OCF of -$1,600 annually throughout the vehicle's expected life of four years as a delivery vehicle; and the Toyota Prius, which will cost $27,000 to purchase and which will have OCF of -$750 annually throughout that vehicle's expected six-year life. Both cars will be worthless at the end of their life. If you intend to replace whichever type of car you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 10 percent, what is the EAC of the most expensive car?

Your firm needs a machine which costs $50,000, and requires $2,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 35 percent and a discount rate of 10 percent. If this machine can be sold for $3,000 at the end of year 5, what is the after-tax salvage value?

Your company is considering the purchase of a new machine. The original cost of the old machine was $75,000; it is now five 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 six 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 five-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?

You are evaluating a project for your company. You estimate the sales price to be $50 per unit and sales volume to be 5,000 units in year 1; 10,000 units in year 2; and 2,500 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $75,000 per year. The project requires an initial investment of $25,000 in assets that 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 $5,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 34 percent and the required return on the project is 13 percent. What change in NWC occurs at the end of year 1?

Your company is considering a new project that will require $10,000 of new equipment at the start of the project. The equipment will have a depreciable life of five years and will be depreciated to a book value of $3,000 using straight-line depreciation. The cost of capital is 9 percent, and the firm's tax rate is 34 percent. Estimate the present value of the tax benefits from depreciation.

All of the following can be included in the depreciable basis of an asset EXCEPT:

Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.70. The flotation cost for equity is 6 percent, the flotation cost for debt is 3 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the firm's flotation-adjusted cash flow in year 0?

A new project would require an immediate increase in raw materials in the amount $6,000. The firm expects that accounts payable will automatically increase $2,000. How much must the firm expect its investment in net working capital to increase if they accept this project?

Equipment was purchased for $50,000 plus $2,500 in freight charges. Installation costs were $1,500 and sales tax totaled $1,000. Hiring a special consultant to provide advice during the selection of the equipment cost $3,000. What is this asset's depreciable basis?

For which situation below would one need to "smooth out" the variation in each set of cash flows so that each becomes a perpetuity?

Suppose you sell a fixed asset for $112,000 when its book value is $112,000. If your company's marginal tax rate is 39 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

A local bank is contemplating opening a new branch bank in a large superstore across town from their main office. It is estimated that the new branch will generate $20,000 after expenses each month. The manager wonders if all these revenues should be considered an incremental cash flow. Given this information, which of the following statements is correct?

Suppose you sell a fixed asset for $10,000 when its book value is $2,000. If your company's marginal tax rate is 35 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

Suppose you sell a fixed asset for $99,000 when its book value is $75,000. If your company's marginal tax rate is 39 percent, what is the gain or loss on the sale of the asset?

Your company is considering a project that will cost $100. The project will generate after-tax cash flows of $37.50 per year for five years. The WACC is 10 percent and the firm's D/A ratio is 0.35. The flotation cost for equity is 5 percent, the flotation cost for debt is 2 percent, and your firm does not plan on issuing any preferred stock within its capital structure. If your firm follows the practice of incorporating flotation costs into the project's initial investment, what is the weighted-average flotation cost for the firm?

To correctly project cash flows, we need to consider all of the factors EXCEPT:

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 percent, and the firm's tax rate is 34 percent. Estimate the present value of the tax benefits from depreciation.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $150,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of three years, a $75,000 estimated resale value, and falls under the MACRS seven-year class life. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 0 free cash flow for this project be?