Exam 11: Cash Flows and Other Topics in Capital Budgeting

Toyota's capital budgeting analysis for the Prius,a gas-electric hybrid,was faulty because the car line has not made a profit to date.

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?

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

A project's contribution to firm risk is relevant for undiversified investors or when bankruptcy costs exist.

Creighton Industries is considering the purchase of a new strapping machine,which will cost $150,000,plus an additional $10,500 to ship and install.The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method.The machine is expected to generate new sales of $45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years.The machine is expected to have a salvage value of $20,000.Creighton's income tax rate is 35%.Creighton uses a 12.5% discount rate for capital budgeting purposes.What is the machine's NPV?

Salvage value would most likely NOT be considered by

QRW Corp.needs to replace an old lathe with a new,more efficient model.The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000.(The old machine is being depreciated on a straight-line basis over a ten-year useful life.)The new lathe costs $100,000.It will cost the company $10,000 to get the new lathe to the factory and get it installed.The old machine will be sold as scrap metal for $2,000.The new machine is also being depreciated on a straight-line basis over ten years.Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year.QRW's marginal tax rate is 40%.Additional working capital of $3,000 is required to maintain the new machine and higher sales level.The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life.What is the incremental free cash flow during year 1 of the project?

An opportunity cost is a relevant incremental cost for capital budgeting decisions.

A new machine can be purchased for $1,800,000.It will cost $35,000 to ship and $15,000 to fine-tune the machine.The new machine will replace an older version that is fully depreciated and will be sold for $200,000.The firm's income tax rate is 35%.What is the initial outlay for capital budgeting purposes?

LaSalle Industries is considering the purchase of a new strapping machine,which will cost $150,000,plus an additional $10,500 to ship and install.The new machine will have a 5-year useful life and will be depreciated to zero using the straight-line method.The machine is expected to generate new sales of $45,000 per year and is expected to save $16,000 in labor and electrical expenses over the next 5-years.The machine is expected to have a salvage value of $20,000.LaSalle's income tax rate is 35%.What is the machine's IRR?

Interest payments on debt are not included in a project's incremental cash flows,but are instead accounted for in the project's discount rate.

AFB Corp.needs to replace an old lathe with a new,more efficient model.The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000.(The old machine is being depreciated on a straight-line basis over a ten-year useful life.)The new lathe costs $100,000.It will cost the company $10,000 to get the new lathe to the factory and get it installed.The old machine will be sold as scrap metal for $2,000.The new machine is also being depreciated on a straight-line basis over ten years.Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year.AFB's marginal tax rate is 40%.Additional working capital of $3,000 is required to maintain the new machine and higher sales level.The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life.What is the project's terminal cash flow?

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

Which of the following should be excluded in an analysis of a new project's cash flows?

If bankruptcy costs and/or shareholder under diversification are an issue,what measure of risk is relevant when evaluating project risk in capital budgeting?

Incremental cash flows refer to

John Q.Enterprises is considering two potential investments.The probability distributions of annual end-of-year cash flows for the respective projects are: Both projects will require an initial outlay of $45,000 and will have an estimated life of 6 years.Project A is considered a riskier investment and will have to have a risk-adjusted required rate of return of 15%,while Project B's risk-adjusted required rate of return is 12%. a.Determine the expected value of each project's annual cash flow. b.Determine each project's risk-adjusted net present value.

Agri-Industries purchased some agricultural land at the edge of a large metropolitan area for $250,000 five years ago.In order to have the land classified as agricultural for property tax purposes,the company has been leasing the property to neighboring farmers.The before-tax return from leasing the property is $12,000 per year.This company's corporate tax rate is 35 percent.If the company sells the land for $400,000 today,what is the internal rate of return on this investment?

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

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