Exam 11: Capital Budgeting Cash Flows

If an asset is depreciable and used in business, any loss on the sale of the asset is tax-deductible only against other capital gains income, not against ordinary income.

Table 11.4 Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given. The firm pays 40 percent taxes on ordinary income and capital gains. -Calculate the incremental earnings before depreciation and taxes. (See Table 11.4)

The tax treatment regarding the sale of existing assets that are sold for more than the original purchase price results in ________.

Table 11.3 Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate. -The annual incremental after-tax cash flow from operations for year 1 is ________. (See Table 11.3)

The tax treatment regarding the sale of existing assets that are sold for less than the book value results in ________.

The tax treatment regarding the sale of existing assets that are sold for their book value results in ________.

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent. ________________________________________________________ *Not applicable -For Proposal 3, the tax effect on the sale of the existing asset results in ________. (See Table 11.2)

Table 11.4 Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given. The firm pays 40 percent taxes on ordinary income and capital gains. -Summarize the incremental after-tax cash flow (relevant cash flows) for years t = 0 through t = 5. (See Table 11.4)

A sunk cost is a cash flow that could be realized from the best alternative use of an owned asset.

The tax treatment regarding the sale of existing assets that are sold for more than the book value but less than the original purchase price results in a(n) ________.

The relevant cash flows for a proposed capital expenditure are the incremental after-tax cash outflows and resulting subsequent inflows.

Should financing costs such as the returns paid to bondholders and stockholders be considered in computing after-tax operating cash flows? Why or why not?

A corporation is considering expanding operations to meet growing demand. With the capital expansion, the current accounts are expected to change. Management expects cash to increase by $20,000, accounts receivable by $40,000, and inventories by $60,000. At the same time accounts payable will increase by $50,000, accruals by $10,000, and long-term debt by $100,000. The change in net working capital is ________.

Incremental cash flows represent the additional cash flows expected as a direct result of the proposed project.

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent. ________________________________________________________ *Not applicable -For Proposal 2, the cash flow pattern for the replacement project is ________. (See Table 11.2)

Table 11.4 Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given. The firm pays 40 percent taxes on ordinary income and capital gains. -Calculate the incremental depreciation. (See Table 11.4)

To calculate the initial investment, we subtract all cash inflows occurring at time zero from all cash outflows occurring at time zero.

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent. ________________________________________________________ *Not applicable -For Proposal 3, the book value of the existing asset is ________. (See Table 11.2)

Table 11.3 Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate. -The initial outlay equals ________. (See Table 11.3)

Table 11.5 Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The gluing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated under MACRS using a five-year recovery schedule and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by $17,000 per year. Training costs of employees who will operate the new machine will be a one-time cost of $5,000 which should be included in the initial outlay. The new machine will be depreciated under MACRS using a five-year recovery period. The firm has a 12 percent cost of capital and a 40 percent tax on ordinary income and capital gains. -The payback period for the project is ________. (See Table 11.5)