Exam 9: Fundamentals of Capital Budgeting

To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm's earnings.

Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $130,000; however, a commercial real estate agent has informed you that an outside buyer is interested in purchasing this land would be willing to pay $700,000 for it. When calculating the net present value (NPV)of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is ________.

Use the figure for the question(s)below. -The graph above shows the break-even analysis for the cost of making a certain good. Based on this chart, which of the following is true?

Visby Rides, a livery car company, is considering buying some new luxury cars. After extensive research, they come up with the above estimates of free cash flow from this project. By how much could the discount rate rise before the net present value (NPV)of this project is zero, given that it is currently 10%?

A brewer is launching a new product: brewed ginger ale with a low alcohol content. The brewer plans to spend $4 million promoting this product this year, which is expected to expand the sales of this product to $11 million this year and $8 million next year. They do expect there will be loss of sales of $1 million this year and next year in their other products as customers switch to drinking the new ginger ale. The gross profit margin for the new ginger ale is 40%, the gross profit margin of all of the brewer's other products is 30%, and the brewer's marginal corporate tax rate is 35%. What are incremental earnings arising from the promotional campaign this year?

A bakery invests $40,000 in a light delivery truck. This was depreciated using the five-year MACRS schedule shown above. If the company sold it immediately after the end of year 2 for $21,000, what would be the after-tax cash flow from the sale of this asset, given a tax rate of 40%?

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6,000,000 to buy the machine and $20,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4,000,000 per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of five years and will be depreciated over those five years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 0?

Which of the following costs would you consider when making a capital budgeting decision?

The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2500 canes in year 1. Sales are estimated to grow by 9% each year through year 3. The price per cane that Sisyphean will charge its customers is $16 each and is to remain constant. The canes have a cost per unit to manufacture of $10 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 3% of its annual sales in cash, 5% of its annual sales in accounts receivable, 10% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 9%. The required net working capital in the first year for the Sisyphean Corporation's project is closest to ________.

Which of the following would you NOT consider when making a capital budgeting decision?

If a business owner is using the extra space at home for his business, does it imply a zero opportunity cost for the space?

Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product?

What do you understand by break-even analysis?

The ultimate goal of the capital budgeting process is to ________.

Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected that the project will produce the following cash flows for the first two years (in millions of dollars). The depreciation tax shield for Shepard Industries project in year 2 is closest to ________.

What is the correct tax rate that should be used for capital budgeting decisions?

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense?

A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard?

Which of the following statements is FALSE?

The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year 3. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 10%. The depreciation tax shield for the Sisyphean Corporation's project in the first year is closest to ________.