Exam 9: Fundamentals of Capital Budgeting

A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80 each to produce. Selling, general, and administrative expenses are $500,000. The machinery required to produce the knives cost $1.4 million, depreciated by straight-line depreciation over five years. The maker determines that the EBIT break-even point for units sold and sale price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A, and depreciation are greater than these estimates, so decides to go ahead with manufacturing the knife. Was this the correct decision?

Ford Motor Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $35 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 35% tax rate on its pre-tax income. The amount that Ford Motor Company owes in taxes next year without the launch of the new SUV is closest to ________.

Which of the following statements is FALSE?

An analysis that breaks the net present value (NPV)calculation into its component assumptions and shows how the net present value (NPV)varies as one of the underlying assumptions changes is called ________.

Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?

Temporary Housing Services Incorporated (THSI)is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $21 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $8 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35% Assume that THSI's cost of capital for this project is 15%. The net present value (NPV)of this temporary housing project is closest to ________.

If available, should MACRS be preferred to straight-line depreciation?

Which of the following formulas will correctly calculate Net Working Capital?

Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present value (NPV).

A firm is considering investing in a new machine that will cost $400,000 and will be depreciated straight-line over five years. If the firm's marginal tax rate is 39%, what is the annual depreciation tax shield of purchasing the machine?

Luther Industries has outstanding tax loss carryforwards of $72 million from losses over the past four years. If Luther earns $15 million per year in pre-tax income from now on, in how many years will Luther first pay taxes?

A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. The $20 million should best be considered ________.

What is the major difference between scenario analysis and sensitivity analysis?

Which of the following statements is FALSE?

Bubba Ho-Tep Company reported net income of $290 million for the most recent fiscal year. The firm had depreciation expenses of $100 million and capital expenditures of $150 million. Although it had no interest expense, the firm did have an increase in net working capital of $30 million. What is Bubba Ho-Tep's free cash flow?

Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?

You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an increase in inventory of $8700, an increase in accounts payables of $2300, and an increase in property, plant, and equipment of $48,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is ________.

The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the cost of manufacturing the knives, the selling price of the knives, the number of knives that will then be sold, and the project's net present value (NPV). Which of the following best describes what type of analysis the manager is performing?

The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.

CathFoods will release a new range of candies which contain anti-oxidants. New equipment to manufacture the candy will cost $4 million, which will be depreciated by straight-line depreciation over six years. In addition, there will be $5 million spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of $6 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 35%, what are the incremental earnings in the second year of this project?