Exam 12: Estimating Cash Flows on Capital Budgeting Projects

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.

For which situation below would one need to "smooth out" the variation in each set of cash flows so that each becomes a perpetuity?

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?

You are evaluating a product for your company.You estimate the sales price of the product to be $375 per unit and sales volume to be 500 units in year 1; 1,000 units in year 2; and 200 units in year 3.The project has a three-year life.Variable costs amount to $200 per unit and fixed costs are $100,000 per year.The project requires an initial investment of $175,000 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 $20,000.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 10 percent.What will the year 2 free 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?

A new project would require an immediate increase in raw materials in the amount $17,000.The firm expects that accounts payable will automatically increase $7,000.How much must the firm expect its investment in net working capital to increase if they accept this project?

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?

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?

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 0.35.The flotation cost for equity is 5 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?

The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as:

Suppose you sell a fixed asset for $10,000 when its book value is $2,000.If your company's marginal tax rate is 35 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)?

A financial analyst calculated that the after-tax salvage value for a machine was $10,200.The current book value of the asset is $25,000 and the firm's tax rate is 20 percent.How much could the machine be sold for today?

Suppose you sell a fixed asset for $99,000 when its book value is $75,000.If your company's marginal tax rate is 39 percent,what is the gain or loss on the sale of the asset?

Coke is planning on marketing a new drink called Very Berry Coke which is a mixture of raspberry and blackberry flavors blended to perfection and added to the highly secret Coca-Cola formula.This new product is expected to reduce the sales of their existing product,Cherry Coke,by $10 million per year.This is an example of a:

You are evaluating a project for The Tiff-any golf club,guaranteed to correct that nasty slice.You estimate the sales price of The Tiff-any to be $375 per unit and sales volume to be 1,000 units in year 1; 1,400 units in year 2; and 1,325 units in year 3.The project has a three-year life.Variable costs amount to $225 per unit and fixed costs are $100,000 per year.The project requires an initial investment of $165,000 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 $35,000.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?

Your company is considering a new project that will require $100,000 of new equipment at the start of the project.The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $25,000 using straight-line depreciation.The cost of capital is 11 percent,and the firm's tax rate is 34 percent.Estimate the present value of the tax benefits from depreciation.

A new project would require an immediate increase in raw materials in the amount of $12,000.The firm expects that accounts payable will automatically increase $8,500.How much must the firm expect its investment in net working capital to change if they accept this project?

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 $100,000,and requires $25,000 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 14 percent.What is the depreciation tax shield for this project in year 3?

A local bank is contemplating adding a new ATM to their lobby.They will need another phone line to provide communications that has a monthly cost of $50 per month.This is an example of: