Exam 12: Estimating Cash Flows on Capital Budgeting Projects

Your company is considering a new project that will require $10,000 of new equipment at the start of the project.The equipment will have a depreciable life of five years and will be depreciated to a book value of $3,000 using straight-line depreciation.The cost of capital is 9 percent,and the firm's tax rate is 34 percent.Estimate the present value of the tax benefits from depreciation.

Suppose you sell a fixed asset for $90,000 when its book value is $95,000.If your company's marginal tax rate is 40 percent,what will be the effect on cash flows of this sale (i.e.,what will be the after-tax cash flow of this sale)?

Your company has spent $200,000 on research to develop a new computer game.The firm is planning to spend $300,000 on a machine to produce the new game.Shipping and installation costs of the machine will be capitalized and depreciated; they total $25,000.The machine has an expected life of three years,a $50,000 estimated resale value,and falls under the MACRS seven-year class life.Revenue from the new game is expected to be $400,000 per year,with costs of $150,000 per year.The firm has a tax rate of 35 percent,an opportunity cost of capital of 10 percent,and it expects net working capital to increase by $75,000 at the beginning of the project.What will the cash flows for this three-year project be?

You are trying to pick the least expensive car for your new delivery service.You have two choices: the Scion xA,which will cost $13,000 to purchase and which will have OCF of -$1,200 annually throughout the vehicle's expected life of three years as a delivery vehicle; and the Toyota Prius,which will cost $23,000 to purchase and which will have OCF of -$550 annually throughout that vehicle's expected five-year life.Both cars will be worthless at the end of their life.If you intend to replace whichever type of car you choose with the same thing when its life runs out,again and again out into the foreseeable future,and if your business has a cost of capital of 16 percent,what is the difference in the EAC of the two cars?

Which of the following statements is correct?

Equipment was purchased for $50,000 plus $2,500 in freight charges.Installation costs were $1,500 and sales tax totaled $1,000.Hiring a special consultant to provide advice during the selection of the equipment cost $3,000.What is this asset's depreciable basis?

You are considering the purchase of one of two machines used in your manufacturing plant.Machine A has a life of two years,costs $20,000 initially,and then $4,000 per year in maintenance costs.Machine B costs $25,000 initially,has a life of three years,and requires $3,500 in annual maintenance costs.Either machine must be replaced at the end of its life with an equivalent machine.Which is the better machine for the firm? The discount rate is 14 percent and the tax rate is zero.

You are evaluating two different machines.Machine A costs $25,000,has a five-year life,and has an annual OCF (after tax)of -$6,000 per year.Machine B costs $30,000,has a seven-year life,and has an annual OCF (after tax)of -$5,500 per year.If your discount rate is 10 percent,using EAC which machine would you choose?

Your firm needs a machine which costs $500,000,and requires $10,000 in maintenance for each year of its three-year life.After three years,this machine will be replaced.The machine falls into the MACRS three-year class life category.Assume a tax rate of 35 percent and a discount rate of 15 percent.What is the depreciation tax shield for this project in year 3?

How do replacement projects' cash flows differ from new projects' cash flows?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $50,000.The truck falls into the MACRS three-year class,and it will be sold after three years for $20,000.Use of the truck will require an increase in NWC (spare parts inventory)of $2,000.The truck will have no effect on revenues,but it is expected to save the firm $20,000 per year in before-tax operating costs,mainly labor.The firm's marginal tax rate is 40 percent.What will the free cash flows for this project be?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $70,000.The truck falls into the MACRS three-year class,and it will be sold after three years for $5,000.Use of the truck will require an increase in NWC (spare parts inventory)of $10,000.The truck will have no effect on revenues,but it is expected to save the firm $32,000 per year in before-tax operating costs,mainly labor.The firm's marginal tax rate is 40 percent.What will the operating cash flow for this project be during year 2?

A manufacturing firm is planning on expanding its existing operations.The expansion project is significant and will require the firm to house the expansion in a different location.The firm is considering building on a lot they own across town.The lot is currently vacant and it was paid for nearly 20 years ago.Given this information,which of the following statements is correct?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $250,000.The truck falls into the MACRS three-year class,and it will be sold after three years for $50,000.Use of the truck will require an increase in NWC (spare parts inventory)of $5,000.The truck will have no effect on revenues,but it is expected to save the firm $80,000 per year in before-tax operating costs,mainly labor.The firm's marginal tax rate is 40 percent.What will the operating cash flow for this project be during year 3?

Identify which cash flows we can incrementally apply to a project and which ones we cannot.

You are evaluating a project for The Ultimate recreational tennis racket,guaranteed to correct that wimpy backhand.You estimate the sales price of The Ultimate to be $300 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325 units in year 3.The project has a three-year life.Variable costs amount to $200 per unit and fixed costs are $50,000 per year.The project requires an initial investment of $150,000 in assets which will be depreciated straight-line to zero over the three-year project life.The actual market value of these assets at the end of year 3 is expected to be $25,000.NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year.The tax rate is 30 percent and the required return on the project is 10 percent.What will the free cash flow for this project be in year 3?

Your company is considering the purchase of a new machine.The original cost of the old machine was $75,000; it is now five years old,and it has a current market value of $20,000.The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis,resulting in a current book value of $37,500 and an annual depreciation expense of $7,500.The old machine can be used for six more years but has no market value after its depreciable life is over.Management is contemplating the purchase of a new machine whose cost is $60,000 and whose estimated salvage value is zero.Expected before-tax cash savings from the new machine are $10,000 a year over its full MACRS depreciable life.Depreciation is computed using MACRS over a five-year life,and the cost of capital is 9 percent.Assume a 40 percent tax rate.What will the year 1 operating cash flow for this project be?

Concerning incremental project cash flow,which of these is a cost one would never count as an expense of the project?

You are evaluating a project for your company.You estimate the sales price to be $50 per unit and sales volume to be 5,000 units in year 1; 10,000 units in year 2; and 2,500 units in year 3.The project has a three-year life.Variable costs amount to $10 per unit and fixed costs are $75,000 per year.The project requires an initial investment of $25,000 in assets that will be depreciated straight-line to zero over the three-year project life.The actual market value of these assets at the end of year 3 is expected to be $5,000.NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year.The tax rate is 34 percent and the required return on the project is 13 percent.What change in NWC occurs at the end of year 1?

You are evaluating a project for your company.You estimate the sales price to be $500 per unit and sales volume to be 2000 units in year 1; 3000 units in year 2; and 1500 units in year 3.The project has a three-year life.Variable costs amount to $300 per unit and fixed costs are $200,000 per year.The project requires an initial investment of $325,000 in assets that will be depreciated straight-line to zero over the three-year project life.The actual market value of these assets at the end of year 3 is expected to be $50,000.NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year.The tax rate is 34 percent and the required return on the project is 12 percent.What is the operating cash flow for the project in year 2?