Exam 11: Cash Flows and Other Topics in Capital Budgeting

Acme Auto Repair developed a new diagnostic testing procedure that is expected to increase sales by $10,000 per month.As more drivers bring in their vehicles,Acme expects to also do more oil changes and brake repairs.As a result,inventory levels of oil and brake parts must be increased by $5,000.Revenues from oil changes and brake jobs are expected to increase by $4,000 per month.An example of a synergistic effect from the new diagnostic testing procedure is the

TRL,Inc.has spent $2,000,000 in nonrefundable engineering fees in contemplation of building a convention center and the additional costs to complete the project are $18,000,000.The present value of all benefits the center will produce in its lifetime are $19,000,000,so TRL should not build the convention center.

Humongous Corporation is a multidivisional conglomerate.The Food Division is undergoing a capital budgeting analysis and must estimate the division's beta.This division has a different level of systematic risk than is typical for Humongous Corporation as a whole.The most appropriate method for estimating this beta is

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 tax effect of selling the old machine?

If an old asset is sold for less than its book value the resulting loss will save the company taxes,hence lowering the cost of the project.

Sunk costs are cash outflows that will occur regardless of the current accept/reject decision,and therefore should be excluded from the analysis.

Cash flows associated with a project's termination generally include the salvage value of the project net of any taxes associated with the sale.

A company is expanding and has already signed a lease on new office space that costs $10,000 per month.The company also needs a new information system and hired a consultant to recommend new software.The consultant was paid $5,000 for her recommendation.Now the company is trying to make a choice between three competing software products.In the capital budgeting decision to purchase new software,the monthly rent for the office space is ________ and the consultant's fee is ________.

Which of the following statements about project standing alone risk is true?

If depreciation expense in year one of a project increases for a highly profitable company,

A local restaurant owner is considering expanding into another urban area.The expansion project will be financed through a line of credit with First National 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

KLE Holdings is considering a capital budgeting project with a life of 7 years that requires an initial outlay of $277,400.The probability distribution for annual incremental cash flows is as follows: a.The risk-adjusted required rate of return for this project is 12%.Calculate the risk-adjusted net present value of the project and the project's IRR. b.Should the project be accepted?

Dave Company,Inc.is considering purchasing a new grinding machine with a useful life of five years.The initial outlay for the machine is $165,000.The expected cash inflows are as follows: Given that the firm has a 10% required rate of return,what is the NPV?

Which of the following should not be included as investment costs in evaluating a capital asset?

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 terminal cash flow?

The pure play method

Interest expenses are not included as incremental free cash flows because the cost of funds is recognized as cash flows are discounted back to present value.

The risk-adjusted discount rate method implicitly assumes that distant cash flows have the same risk as near cash flows.

In a replacement decision,the initial outlay is equal to the cost of the new asset less the reduction in depreciation from elimination of the old asset.

Which of the following are included in the terminal cash flow?