Exam 11: Cash Flows and Other Topics in Capital Budgeting

Accounting profits are used to make capital budgeting decisions because generally accepted accounting principles ensure that profits are the best measure of a company's economic activity.

A grocery store decides to offer beer for sale and this decision results in more potato chip sales.This is an example of a synergistic effect.

Laural Inc.is a household products firm that is considering developing a new detergent.In evaluating whether to go ahead with the new detergent project,which of the following statements is most correct?

A major corporation is considering a capital budgeting project that involves the development of a new technology.The controller estimates the net present value to be negative,yet argues that the company should invest in the project.Which of the following statements is most correct?

Changes in capital spending are not incorporated directly into capital budgeting problems because the amounts are included in the operating cash flows through the inclusion of depreciation expense.

Advantages of using simulation include

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

Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision.

The guiding rule in deciding if a free cash flow is incremental is to look at the company with,versus without,the new project.

As a rule,any cash flows that are not affected by the accept/reject criterion should not be included in capital-budgeting analysis.

Ames Manufacturing is considering the purchase of new,sophisticated machinery for a special three-year project.The machinery requires a special lubricating oil that probably will never be used,but must be available at all times should the machine break down.Ames purchases $2,000 of lubricating oil to keep on hand just in case it is needed.At the end of the three-year project,it is expected the lubricating oil can be sold back to the distributor for $2,000.Which of the following statements is most correct?

Free cash flow calculations can be broken down into three parts: cash flows from operations,cash flows associated with working-capital requirements,and financing cash flows relating to interest and dividend payments.

A wildcat oil driller has enough capital to invest in only one project,that is,to drill one well in an East Texas oil field.A major oil company is drilling 100 wells in the same field.The probability of successfully striking oil is 10% for any well drilled in this field.Which of the following statements is most correct concerning the risk involved in these capital budgeting projects?

PDF 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.PDF's marginal tax rate is 40%.Additional working capital of $3,000 is required to maintain the new machine and higher sales level.The initial outlay for the new machine is

Hershy's expects to sell $2 million of its new candy bar,although $200,000 of this amount would have been spent on its existing candy bar.The $2 million is the appropriate cash inflow for the new candy bar project,while the $200,000 will be counted against the return on the old candy bar.

Increases in working capital needs should be included as part of the initial outlay of a project,but decreases in working capital for a project should not be considered because they are not guaranteed.

P.D.Corporation is considering the purchase of a high-speed lathe that has an invoice price of $250,000.The cost to ship the lathe to P.D.'s factory is $10,000,and the existing facilities will require modifications that are expected to cost $20,000.The machine will be depreciated on a straight-line basis over its useful life of 10 years,assuming no salvage value.P.D.Corporation is planning on paying for the lathe using a line of credit at the bank that has an interest rate of 6 percent per year.The lathe is expected to increase production and sales.Sales are expected to increase by $100,000 per year.Inventory and accounts receivable balances are expected to increase by $10,000 and $20,000 respectively.Expenses to operate the lathe are $25,000 per year.P.D.'s marginal tax rate is 40%. a.Calculate the initial outlay required to fund this project. b.Calculate the incremental after-tax cash flow in year one of the project.

Incremental cash flows refer to

Salvage value would most likely not be considered by

PDF 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.PDF'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 years 2 through 10 of the project?