Exam 11: Cash Flows and Other Topics in Capital Budgeting

Which of the following expenses associated with a project should not be included in a capital budgeting analysis?

Proceeds from the issuance of new debt and principal payments upon maturity of debt used to finance a project should be included in the calculation of the project's after-tax cash flows.

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.

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

Adding gourmet coffee stations to my convenience store is expected to increase sales of my breakfast sandwiches; however,the sales of breakfast sandwiches should not be included in the evaluation of the gourmet coffee project because only relevant,incremental cash flows should be considered.

A new machine can be purchased for $1,200,000.It will cost $35,000 to ship and $15,000 to modify the machine.A $12,000 recently completed feasibility study indicated that the firm can employ an existing factory owned by the firm,which would have otherwise been sold for $180,000.The firm will borrow $750,000 to finance the acquisition.Total interest expense for 5-years is expected to approximate $350,000.What is the investment cost of the machine for capital budgeting purposes?

In general,a project's free cash flows will fall in one of the following three categories: initial outlay,differential cash flows over the project's life,and the terminal cash flow.

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?

Any increase in interest payments caused by a project should be counted in the incremental cash flows.

For companies in competitive markets,the evolution and introduction of new products may serve more to preserve market share than to expand it.

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.

Zinc,Inc.is considering the acquisition of a new processing line.The processor can be purchased for $4,550,000.It will cost $65,000 to ship and $190,500 to install the processor.A recently completed feasibility study that was performed at a cost of $45,000 indicated that the processor would produce a positive NPV.Studies have shown that employee-training expenses will be $150,000.What is the total investment in the processing line for capital budgeting purposes?

A method for estimating a project's beta that attempts to identify publicly traded firms engage solely in the same business as the project is called the pure play method.

Project XYZ requires an investment in equipment of $600,000 to replace existing equipment.The existing equipment will produce after-tax salvage value of $70,000.Net working capital requirements are increased by $50,000.What is the total cash outflow at time zero?

Which of the following should be included in the initial outlay?

Increased depreciation expenses affect tax-related cash flows by

As part of its expansion project,A.J.Industries Equipment Division has expanded its office space by 200 square feet.The company's administrative overhead is allocated based on the square footage of each business segment.Although the total administrative overhead for the company will remain the same,the Equipment Division will be charged more for administrative overhead.For the Equipment Division expansion project,the administrative overhead is an example of a(n)

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

Financial theory assumes that individuals are risk averse.

Your company is considering the replacement of an old delivery van with a new one that is more efficient.The old van cost $40,000 when it was purchased 5 years ago.The old van is being depreciated using the simplified straight-line method over a useful life of 8 years.The old van could be sold today for $7,000.The new van has an invoice price of $80,000,and it will cost $6,000 to modify the van to carry the company's products.Cost savings from use of the new van are expected to be $28,000 per year for 5 years,at which time the van will be sold for its estimated salvage value of $18,000.The new van will be depreciated using the simplified straight-line method over its 5-year useful life.The company's tax rate is 35%.Working capital is expected to increase by $5,000 at the inception of the project,but this amount will be recaptured at the end of year five.What is the incremental free cash flow for year one?