Exam 12: Estimating Cash Flows on Capital Budgeting Projects

As new capital budgeting projects arise,we must estimate:

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?

Your firm needs a computerized machine tool lathe that costs $50,000,requires $10,000 in installation,and another $12,000 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 30 percent and a discount rate of 12 percent.If the lathe can be sold for $7,000 at the end of year 3,what is the after-tax salvage value?

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.

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 change in NWC occurs at the end of year 1?

KADS,Inc.,has spent $400,000 on research to develop a new computer game.The firm is planning to spend $50,000 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 $15,000 estimated resale value,and falls under the MACRS five-year class life.Revenue from the new game is expected to be $500,000 per year,with costs of $300,000 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 $55,000 at the beginning of the project.What will the year 3 free cash flow for this project be?

ABC Engineering just purchased 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 $10 per unit and sales volume to be 3,000 units in year 1; 10,000 units in year 2; and 1,000 units in year 3.The project has a three-year life.Variable costs amount to $3 per unit and fixed costs are $25,000 per year.The project requires an initial investment of $50,000 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 $10,000.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 15 percent.What change in NWC occurs at the end of year 1?

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $60,000.The truck falls into the MACRS three-year class,and it will be sold after three years for $14,000.Use of the truck will require an increase in NWC (spare parts inventory)of $3,000.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 operating cash flow for this project be during year 3?

Accelerated depreciation allows firms to:

AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000.This is an example of a(n):

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?

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 $35,000.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 $80,000 and whose estimated salvage value is zero.Expected before-tax cash savings from the new machine are $15,000 a year over its full MACRS depreciable life.Depreciation is computed using MACRS over a five-year life,and the cost of capital is 15 percent.Assume a 40 percent tax rate.What will the year 1 operating cash flow for this project be?

Your firm needs a machine which costs $50,000,and requires $2,000 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.What is the depreciation tax shield for this project in year 3?

Your firm needs a computerized machine tool lathe that costs $50,000,requires $10,000 in installation,$5,000 in freight charges,and another $12,000 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 30 percent and a discount rate of 12 percent.If the lathe can be sold for $7,000 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 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?

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 $5,000.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 $25,000 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?

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?

Which of the following statements is correct?

You are evaluating a project for your company.You estimate the sales price to be $10 per unit and sales volume to be 3,000 units in year 1; 10,000 units in year 2; and 1,000 units in year 3.The project has a three-year life.Variable costs amount to $3 per unit and fixed costs are $25,000 per year.The project requires an initial investment of $50,000 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 $10,000.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 15 percent.What is the operating cash flow for the project in year 2?