Exam 11: Cash Flows and Other Topics in Capital Budgeting

Eastlick Dairy invests in a new kind of frozen dessert called polar cream that becomes very popular.So many new customers come to the store that the sales of existing ice cream products are increased.The extra sales revenue

What method is used for calculation of the accounting beta?

The simulation approach provides us with

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 year 1 of the project?

Jones Company expects the following results in year one of a new project: The annual change in operating cash flow is equal to

The most relevant measure of risk for capital budgeting is project standing alone risk.

Zinc,Inc.is considering the acquisition of a new processing line.The processor can be purchased for $3,750,000; it will have a 10-year useful life.It will cost $165,000 to ship and $85,250 to install the processor.A recently completed feasibility study that was performed at a cost of $65,000 indicated that the processor would produce a positive NPV.The processor will be depreciated using the straight-line method to zero expected salvage value.Studies have shown that employee-training expenses will be $125,000.What will be the annual depreciation expense of the processing line for capital budgeting purposes?

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 project's terminal cash flow?

A new project is expected to generate $800,000 in revenues,$250,000 in cash operating expenses,and depreciation expense of $150,000 in each year of its 10-year life.The corporation's tax rate is 35%.The project will require an increase in net working capital of $85,000 in year one and a decrease in net working capital of $75,000 in year ten.What is the free cash flow from the project in year one?

Since stockholders are able to reduce their exposure to risk by efficiently diversifying their holdings of securities,there is no reason for individual firms to seek diversification of their holdings of assets.

If the increase in net working capital is recovered entirely at the end of the project then it may be ignored.

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

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

Sensitivity analysis involves changing one variable at a time.

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.

The initial outlay includes the cost of purchasing the asset and getting is operational,but this excludes any training costs for employees which should be included as part of differential cash flows over the life of the project.

The financial manager selecting one of two projects of differing risk should

Capital budgeting projects that expand sales are more likely to involve increases in working capital than are projects that involve the replacement of existing assets.

Sunk costs are

Kelly Corporation is considering an investment proposal that requires an initial investment of $150,000 in equipment.Fully depreciated existing equipment may be disposed of for $40,000 pre-tax.The proposed project will have a five-year life,and is expected to produce additional revenue of $65,000 per year.Expenses other than depreciation will be $15,000 per year.The new equipment will be depreciated to zero over the five-year useful life,but it is expected to actually be sold for $20,000.Kelly has a 35% tax rate. a.What is the net initial outlay for the proposed project? b.What is the operating cash flow for years 1-4? c.What is the total cash flow at the end of year five (operating cash flow for year 5 plus terminal cash flow)?