Exam 11: Cash Flows and Other Topics in Capital Budgeting

You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from Equipment Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the terminal cash flow for this project?

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

J.B.Enterprises purchased a new molding machine for $85,000.The company paid $8,000 for shipping and another $7,000 to get the machine integrated with the company's existing assets.J.B.must maintain a supply of special lubricating oil just in case the machine breaks down.The company purchased a supply of oil for $4,000.The machine is to be depreciated on a straight-line basis over its expected useful life of 8 years.What will depreciation expense be during the first year?

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

Which of the following is NOT an important consideration in measuring risk for a capital budgeting project for a well-diversified firm?

You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from Equipment Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the incremental free cash flow for the first year of the project?

A project's standing alone risk allows for diversification within a sole firm.

You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from Equipment Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the initial outlay required to fund this project?

XYZ company is considering replacing an old machine with a new one.Two months ago their chief engineer completed a training seminar on the new machine's operation and efficiency.The $3,000 cost for this training session has already been paid.If the new machine is purchased,it would require $7,000 in installation and modification costs to make it suitable for operation in the factory.The old machine originally cost $80,000 five years ago and is being depreciated by $10,000 per year.The new machine will cost $100,000 before installation and modification.It will be depreciated by $12,000 per year.The old machine can be sold today for $12,000.The marginal tax rate for the firm is 40%.Compute the relevant initial outlay in this capital budgeting decision.

Fluctuating currency exchange rates should be ignored in capital budgeting because for a U.S.firm,all incremental cash flows will be properly measured in dollars.

Additional investment in working capital,even if it may be recovered at the end of a project,must be included in capital budgeting analysis because of the time value of money.

If a project uses an asset the corporation already owns,the cost of that asset for capital budgeting purposes is zero to reflect the advantage the project has over projects that require the purchase of new assets.

Depreciation is a non-cash deduction so it may be ignored in the calculation of a project's incremental after-tax cash flows.

In measuring cash flows we are interested only in the incremental or incremental after-tax cash flows that are attributed to the investment proposal being evaluated.

Increasing depreciation expense results in a decrease of the incremental after-tax free cash flow.