Exam 9: Fundamentals of Capital Budgeting

A capital budget lists the potential projects a company may undertake in future years.

CathFoods will release a new range of candies which contain antioxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over four 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 $4 million per year for four years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 35%, what are the incremental free cash flows in the second year of this project?

An exploration of the effect of changing multiple project parameters on net present value (NPV)is called ________.

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. The depreciation schedule shown is for three-year, straight-line depreciation. By how much would the net present value (NPV)of this project be increased, if the cars were depreciated by the MACRS schedule shown below given that the cost of capital is 10%?

Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why?

What is the most important function of sensitivity analysis?

An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?

Which of the following best defines incremental earnings?

You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an investment of $47,000 in new equipment. This equipment will be depreciated straight-line over five years. If your firm's marginal corporate tax rate is 35%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation?

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $5,000,000 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 raise gross profits by $4,500,000 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 six years and will be depreciated over those six years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 2?

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 2400 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 $15 each and is to remain constant. The canes have a cost per unit to manufacture of $8 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, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 8%. The change in net working capital from year 1 to year 2 is closest to ________.

Use the figure for the question(s)below. -A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean?

Which of the following statements is FALSE?