Exam 12: Estimating Cash Flows on Capital Budgeting Projects

You are evaluating two different machines.Machine A costs $10,000,has a five-year life,and has an annual OCF (after tax)of -$2,500 per year.Machine B costs $15,000,has a seven-year life,and has an annual OCF (after tax)of -$2,000 per year.If your discount rate is 14 percent,using EAC which machine would you choose?

KADS,Inc.,has spent $400,000 on research to develop a new computer game.The firm is planning to spend $250,000 on a machine to produce the new game.Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000.The machine has an expected life of three years,a $75,000 estimated resale value,and falls under the MACRS seven-year class life.Revenue from the new game is expected to be $500,000 per year,with costs of $200,000 per year.The firm has a tax rate of 35 percent,an opportunity cost of capital of 15 percent,and it expects net working capital to increase by $100,000 at the beginning of the project.What will the year 1 free cash flow for this project be?

Will operating cash flow typically be larger or smaller than net income? Why?

ABC Engineering just bought a new machine.All of the following are examples of incremental cash flows EXCEPT:

You are evaluating a project for your company.You estimate the sales price to be $25 per unit and sales volume to be 4,000 units in year 1; 7,000 units in year 2; and 1,000 units in year 3.The project has a three-year life.Variable costs amount to $10 per unit and fixed costs are $50,000 per year.The project requires an initial investment of $10,000 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 $1,000.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 34 percent and the required return on the project is 10 percent.What is the operating cash flow for the project in year 2?

When looking at which of these types of projects,one must consider any cash flows that arise from surrendering old equipment before the end of its useful life?

Your firm needs a machine which costs $125,000,and requires $5,000 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 10 percent.If this machine can be sold for $15,000 at the end of year 3,what is the after-tax salvage value?

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 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 $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 2?

Your company is considering a project that will cost $100.The project will generate after-tax cash flows of $37.50 per year for five years.The WACC is 10 percent and the firm's D/A ratio is 0.70.The flotation cost for equity is 6 percent,the flotation cost for debt is 3 percent,and your firm does not plan on issuing any preferred stock within its capital structure.If your firm follows the practice of incorporating flotation costs into the project's initial investment,what is the firm's flotation-adjusted cash flow in year 0?

Your company is considering a project that will cost $175.The project will generate after-tax cash flows of $37.50 per year for five years.The WACC is 10 percent and the firm's D/A ratio is 0.62.The flotation cost for equity is 5 percent,the flotation cost for debt is 3 percent,and your firm does not plan on issuing any preferred stock within its capital structure.If your firm follows the practice of incorporating flotation costs into the project's initial investment,what is the firm's flotation-adjusted cash flow in year 0?

Which of these is the process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements?

Your firm needs a machine which costs $90,000,and requires $30,000 in maintenance for each year of its five-year life.After five years,this machine will be replaced.The machine falls into the MACRS five-year class life category.Assume a tax rate of 35 percent and a discount rate of 13 percent.What is the depreciation tax shield for this project in year 5?

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 12 percent,what is the difference in the EAC of the two cars?

A decrease in net working capital (NWC)is treated as a:

Your company is considering the purchase of a new machine.The original cost of the old machine was $100,000; it is now five years old,and it has a current market value of $40,000.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 $50,000 and an annual depreciation expense of $10,000.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 $80,000 and whose estimated salvage value is zero.Expected before-tax cash savings from the new machine are $13,000 a year over its full MACRS depreciable life.Depreciation is computed using MACRS over a five-year life,and the cost of capital is 10 percent.Assume a 40 percent tax rate.What will the year 1 operating cash flow for this project be?

You are trying to pick the least-expensive machine for your company.You have two choices: machine A,which will cost $50,000 to purchase and which will have OCF of -$3,500 annually throughout the machine's expected life of three years; and machine B,which will cost $75,000 to purchase and which will have OCF of -$4,900 annually throughout that machine's four-year life.Both machines will be worthless at the end of their life.If you intend to replace whichever type of machine 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 14 percent,which one should you choose?

Your company is considering a project that will cost $100.The project will generate after-tax cash flows of $37.50 per year for five years.The WACC is 10 percent and the firm's D/A ratio is 0.40.The flotation cost for equity is 3 percent,the flotation cost for debt is 2 percent,and your firm does not plan on issuing any preferred stock within its capital structure.If your firm follows the practice of incorporating flotation costs into the project's initial investment,what is the weighted-average flotation cost for the firm?

Which statement is true regarding cost-cutting proposals?

Due to rapid growth,a computer superstore is contemplating expanding by adding another location.Which of the following items should the financial officer NOT include in estimating the cash flow associated with this expansion?

KADS,Inc.,has spent $400,000 on research to develop a new computer game.The firm is planning to spend $150,000 on a machine to produce the new game.Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000.The machine has an expected life of three years,a $75,000 estimated resale value,and falls under the MACRS seven-year class life.Revenue from the new game is expected to be $600,000 per year,with costs of $250,000 per year.The firm has a tax rate of 35 percent,an opportunity cost of capital of 15 percent,and it expects net working capital to increase by $100,000 at the beginning of the project.What will the year 0 free cash flow for this project be?