Exam 11: Cash Flows and Other Topics in Capital Budgeting

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

The simulation approach provides us with

A typical decision rule used in simulation is to accept the project if the probability is sufficiently high that the net present value is positive.

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

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

Increases in inventory and accounts receivable expected to occur if a proposed advertising campaign is undertaken are examples of sunk costs.

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

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

Which of the following is NOT considered in the calculation of incremental cash flows?

One example of a terminal cash flow is the recapture of the net working capital associated with the project.

Reducing the probability of bankruptcy is a benefit of diversification.

Advantages of using simulation include

LEE Corporation intends to purchase equipment for $1,500,000.The equipment has a 5-year useful life and will be depreciated on a straight-line basis.Addition of the equipment requires additional working capital of $20,000.The $20,000 is expected to be recaptured at the end of the project.LEE's marginal tax rate is 40%.Use of the equipment is expected to change the company's reported EBIT by $600,000 in year one,$700,000 in year two,$550,000 in year three,$200,000 in year four,and $100,000 in year five.Due to changing market conditions,the equipment did have a salvage value of $100,000 at the end of year five. a.Calculate the initial outlay and the incremental free cash flows over the life of the project. b.If the risk-adjusted discount rate for this project is 20%,calculate the project's net present value and internal rate of return and comment on the acceptability of the project.

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