CA"H #$%& E"T'MAT'%( CHAPTE A(D !!'") A(A

CA"H #$%& E"T'MAT'%( CHAPTE A(D !!
'") A(A$*"'"
(Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual Easy:

Relevant cash flows
1
Answer: d
Diff: E
Which of the following statements is most correct? a. The rate of depreciation will often affect operating cash flows, even though depreciation is not a cash expense. b. Corporations should fully account for sunk costs when making investment decisions. c. Corporations should fully account for opportunity costs when making investment decisions. d. tatements a and c are correct. e. !ll of the statements above are correct.
Relevant cash flows

"
Answer: c
Diff: E
! company is considering a new pro#ect. The company$s C%& plans to calculate the pro#ect$s '() by discounting the relevant cash flows *which include the initial up+front costs, the operating cash flows, and the terminal cash flows, at the company$s cost of capital *W!CC,. Which of the following factors should the C%& include when estimating the relevant cash flows? a. b. c. d. e. !ny sunk costs associated with the pro#ect. !ny interest expenses associated with the pro#ect. !ny opportunity costs associated with the pro#ect. tatements b and c are correct. !ll of the statements above are correct. Answer: d Diff: E
Relevant cash flows

-
When evaluating potential pro#ects, which of the following factors should be incorporated as part of a pro#ect$s estimated cash flows? a. !ny sunk costs that were incurred in the past prior to considering the proposed pro#ect. b. !ny opportunity costs that are incurred if the pro#ect is undertaken. c. !ny externalities *both positive and negative, that are incurred if the pro#ect is undertaken. d. tatements b and c are correct. e. !ll of the statements above are correct.
Relevant cash flows

.
Answer: b
Diff: E
. Which of the following statements is most correct?
Chapter 11 - Page 1
a. When evaluating corporate pro#ects it is important to include all sunk costs in the estimated cash flows. b. When evaluating corporate pro#ects it is important to include all relevant externalities in the estimated cash flows. c. /nterest expenses should be included in pro#ect cash flows. d. tatements a and b are correct. e. !ll of the statements above are correct. Relevant cash flows
0
Answer: c a cash flow that results
Diff: E from the
Which of the following is not decision to accept a pro#ect?
a. Changes in net operating working capital. b. hipping and installation costs. c. unk costs. d. &pportunity costs. e. 1xternalities. Relevant cash flows
2
Answer: b
Diff: E
When evaluating a new pro#ect, the firm should consider all of the following factors except3 a. Changes in net operating working capital attributable to the pro#ect. b. (revious expenditures associated with a market test to determine the feasibility of the pro#ect, if the expenditures have been expensed for tax purposes. c. Current rental income of a building owned by the firm if it is not used for this pro#ect. d. The decline in sales of an existing product directly attributable to this pro#ect. e. !ll of the statements above should be considered.
Relevant cash flows

4
Answer: d
Diff: E
Which of the following items should 5ev$s 5everage /nc. take into account when evaluating a proposed prune #uice pro#ect? a. The company spent 6-77,777 two years ago to renovate its Cincinnati plant. These renovations were made in anticipation of another pro#ect that the company ultimately did not undertake. b. /f the company did not proceed with the prune #uice pro#ect, the Cincinnati plant could generate leasing income of 640,777 a year. c. /f the company proceeds with the prune #uice pro#ect, it is estimated that sales of the company$s apple #uice will fall by - percent a year. d. tatements b and c are correct. e. !ll of the statements above are correct.
Relevant cash flows

8
Answer: d
Diff: E
Which of the following should a company consider in an analysis when evaluating a proposed pro#ect?
Chapter 11 - Page 2
a. The new pro#ect is expected to reduce sales of the company$s existing products by 0 percent a year. b. )acant facilities not currently leased out could instead be leased out for 617 million a year. c. The company spent 6-7 million last year to improve the vacant facilities in which the new pro#ect will be housed. d. tatements a and b are correct. e. !ll of the statements above are correct. Relevant cash flows
9
Answer: d
Diff: E
:ancock %urniture /nc. is considering new expansion plans for building a new store. /n reviewing the proposed new store, several members of the firm$s financial staff have made a number of points regarding the proposed pro#ect. Which of the following items should the C%& include in the analysis when estimating the pro#ect$s net present value *'(),? a. The new store is expected to take away sales from two of the firm$s existing stores located in the same town. b. The company owns the land that is being considered for use in the proposed pro#ect. This land could instead be leased to a local developer. c. The company spent 6" million two years ago to put together a national advertising campaign. This campaign helped generate the demand for some of its past products, which have helped make it possible for the firm to consider opening a new store. d. tatements a and b are correct. e. !ll of the statements above are correct.
Relevant and incremental cash flows

17
Answer: a
Diff: E
Twin :ills /nc. is considering a proposed pro#ect. ;iven available information, it is currently estimated that the proposed pro#ect is risky but has a positive net present value. Which of the following factors would make the company less likely to adopt the current pro#ect? a. /t is revealed that if the company proceeds with the proposed pro#ect, the company will lose two other accounts, both of which have positive '()s. b. /t is revealed that the company has an option to back out of the pro#ect " years from now, if it is discovered to be unprofitable. c. /t is revealed that if the company proceeds with the pro#ect, it will have an option to repeat the pro#ect . years from now. d. tatements a and b are correct. e. tatements b and c are correct.
New project cash flows

11
Answer: a
Diff: E
! company is considering a proposed expansion to its facilities. of the following statements is most correct?
Which
a. /n calculating the pro#ect<s operating cash flows, the firm should not subtract out financing costs such as interest expense, since Chapter 11 - Page 3
b. c.
d. e.
these costs are already included in the W!CC, which is used to discount the pro#ect$s net cash flows. ince depreciation is a non+cash expense, the firm does not need to know the depreciation rate when calculating the operating cash flows. When estimating the pro#ect$s operating cash flows, it is important to include any opportunity costs and sunk costs, but the firm should ignore cash flows from externalities since they are accounted for elsewhere. tatements a and c are correct. 'one of the statements above is correct. Answer: b Diff: E
Corporate risk
1"
Which of the following statements is correct? a. Well+diversified stockholders do not consider corporate risk when determining re=uired rates of return. b. >ndiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk. c. 1mpirical studies of the determinants of re=uired rates of return *k, have found that only market risk affects stock prices. d. ?arket risk is important but does not have a direct effect on stock price because it only affects beta. e. !ll of the statements above are correct.
Risk analysis
1-
Answer: e
Diff: E
Which of the following is not discussed in the text as a method for analy@ing risk in capital budgeting? a. ensitivity analysis. b. 5eta, or C!(?, analysis. c. ?onte Carlo simulation. d. cenario analysis. e. !ll of the statements above are discussed in the text as methods for analy@ing risk in capital budgeting.
Chapter 11 - Page 4
Risk analysis
1.
Answer: c
Diff: E
Aieber Technologies is considering two potential pro#ects, B and C. /n assessing the pro#ects$ risk, the company has estimated the beta of each pro#ect and has also conducted a simulation analysis. Their efforts have produced the following numbers3 1xpected '() tandard deviation *'(), 1stimated pro#ect beta 1stimated correlation of pro#ect$s cash flows with the cash flows of the company$s existing pro#ects. (ro#ect B 6-07,777 6177,777 1.. Cash flows are not highly correlated with the cash flows of the existing pro#ects. (ro#ect C 6-07,777 6107,777 7.8 Cash flows are highly correlated with the cash flows of the existing pro#ects.
Which of the following statements is most correct? a. (ro#ect B has a higher level of stand+alone risk relative to (ro#ect C. (ro#ect B has a higher level of corporate risk relative to (ro#ect C. (ro#ect B has a higher level of market risk relative to (ro#ect C. tatements b and c are correct. !ll of the statements above are correct. Answer: a Diff: E N
b. c. d. e.
Risk analysis
10
Currently, (urcell (roducts /nc. has a beta of 1.7, and the sales of all of its products tend to be positively correlated with the overall economy and the overall market. The company estimates that a proposed new pro#ect has a higher standard deviation than the typical pro#ect undertaken by the firm. The company also estimates that the new pro#ect$s sales will do better when the overall economy is down and do poorly when the overall economy is strong. &n the basis of this information, which of the following statements is most correct? a. The proposed new pro#ect has more stand+alone risk than the firm$s typical pro#ect. b. /f undertaken, the proposed new pro#ect will increase the firm$s corporate risk. c. /f undertaken, the proposed new pro#ect will increase the firm$s market risk. d. tatements a and b are correct. e. !ll of the statements above are correct.
Chapter 11 - Page 5
Risk analysis
12
Answer: e
Diff: E
/n conducting its risk analysis, :anratty /nc. estimates that on a stand+alone basis, a proposed pro#ect$s estimated returns has more risk than its existing pro#ects. The pro#ect is also expected to be more sensitive to movements in the overall economy and market than are its existing pro#ects. :owever, :anratty estimates that the overall standard deviation of the company$s total returns would fall if the company were to go ahead with this pro#ect. &n the basis of this information, which of the following statements is most correct? a. The proposed pro#ect$s estimated returns have a higher standard deviation compared to the average existing pro#ect. b. The proposed pro#ect will reduce the company$s corporate risk. c. The proposed pro#ect will increase the company$s market risk. d. The proposed pro#ect$s returns are not perfectly correlated with the returns of its existing pro#ects. e. !ll of the statements above are correct.
Accepting risky projects

14
Answer: e
Diff: E
! firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. /n evaluating this asset, the decision maker should a. /ncrease the /DD of the asset to reflect the greater risk. b. /ncrease the '() of the asset to reflect the greater risk. c. De#ect the asset, since its acceptance would increase the firm$s risk. d. /gnore the risk differential, if the asset to be accepted would comprise only a small fraction of the firm$s total assets. e. /ncrease the cost of capital used to evaluate the pro#ect to reflect the pro#ect$s higher risk.
Risk adjustment
18
Answer: b
Diff: E
Disk in a revenue+producing pro#ect can best be ad#usted for by a. b. c. d. e. /gnoring it. !d#usting the discount rate upward for increasing risk. !d#usting the discount rate downward for increasing risk. (icking a risk factor e=ual to the average discount rate. Deducing the '() by 17 percent for risky pro#ects. Answer: b Diff: E
Risk and project selection

19
! company estimates that an average+risk pro#ect has a W!CC of 17 percent, a below+average risk pro#ect has a W!CC of 8 percent, and an above+average risk pro#ect has a W!CC of 1" percent. Which of the following independent pro#ects should the company accept? a. (ro#ect ! has average risk and an /DD E 9 percent. b. (ro#ect 5 has below+average risk and an /DD E 8.0 percent. c. (ro#ect C has above+average risk and an /DD E 11 percent.
Chapter 11 - Page 6
d. !ll of the pro#ects above should be accepted. e. 'one of the pro#ects above should be accepted. Risk and project selection
"7
Answer: c
Diff: E
Fowningtown /ndustries has an overall *composite, W!CC of 17 percent. This cost of capital reflects the cost of capital for a Fowningtown pro#ect with average riskG however, there are large risk differences among its pro#ects. The company estimates that low+risk pro#ects have a cost of capital of 8 percent and high+risk pro#ects have a cost of capital of 1" percent. The company is considering the following pro#ects3 (ro#ect ! 5 C F 1 1xpected Deturn 10H 1" 11 9 2 Disk :igh !verage :igh Aow Aow
Which of the pro#ects should the company select to maximi@e shareholder wealth? a. b. c. d. e. ! and !, 5, !, 5, !, 5, !, 5, 5. and C. and F. C, and F. C, F, and 1. Answer: c Diff: E
ensitivity! scenario! and simulation analyses

"1
Which of the following statements is most correct? a. ensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects. b. &ne advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of certain effects occurring, whereas scenario analysis does not consider probabilities. c. imulation analysis is a computeri@ed version of scenario analysis that uses continuous probability distributions of the input variables. d. tatements a and b are correct. e. !ll of the statements above are correct.
Chapter 11 - Page 7
Medium:
Cash flows and accounting measures
""
Answer: d
Diff: "
Which of the following statements is correct? a. !n asset that is sold for less than book value at the end of a pro#ect$s life will generate a loss for the firm and will cause an actual cash outflow attributable to the pro#ect. b. &nly incremental cash flows are relevant in pro#ect analysis and the proper incremental cash flows are the reported accounting profits because they form the true basis for investor and managerial decisions. c. /t is unrealistic to expect that increases in net operating working capital re=uired at the start of an expansion pro#ect are simply recovered at the pro#ect$s completion. Thus, these cash flows are included only at the start of a pro#ect. d. 1=uipment sold for more than its book value at the end of a pro#ect$s life will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value. e. 'one of the statements above is correct.
Relevant cash flows

"-
Answer: d
Diff: "
!dams !udio is considering whether to make an investment in a new type of technology. Which of the following factors should the company consider when it decides whether to undertake the investment? a. The company has already spent 6- million researching the technology. b. The new technology will affect the cash flows produced by its other operations. c. /f the investment is not made, then the company will be able to sell one of its laboratories for 6" million. d. tatements b and c should be considered. e. !ll of the statements above should be considered.
Relevant cash flows

".
Answer: d
Diff: "
Aaurier /nc. is a household products firm that is considering developing a new detergent. /n evaluating whether to go ahead with the new detergent pro#ect, which of the following items should Aaurier explicitly include in its cash flow analysis? a. The company will produce the detergent in a vacant facility that they renovated five years ago at a cost of 6477,777. b. The company will need to use some e=uipment that it could have leased to another company. This e=uipment lease could have generated 6"77,777 per year in after+tax income. c. The new detergent is likely to significantly reduce the sales of the other detergent products the company currently sells. d. tatements b and c are correct. e. !ll of the statements above are correct.
Chapter 11 - Page 8
Relevant cash flows

"0
Answer: d
Diff: "
anford I on /nc. is thinking about expanding their business by opening another shop on property they purchased 17 years ago. Which of the following items should be included in the analysis of this endeavor? a. The property was cleared of trees and brush five years ago at a cost of 60,777. b. The new shop is expected to affect the profitability of the existing shop since some current customers will transfer their business to the new shop. The firm estimates that profits at the existing shop will decrease by 17 percent. c. anford I on can lease the entire property to another company *that wants to grow flowers on the lot, for 60,777 per year. d. 5oth statements b and c should be included in the analysis. e. !ll of the statements above should be included in the analysis.
Relevant cash flows

"2
Answer: d
Diff: "
(ickles Corp. is a company that sells bottled iced tea. The company is thinking about expanding its operations into the bottled lemonade business. Which of the following factors should the company incorporate into its capital budgeting decision as it decides whether or not to enter the lemonade business? a. /f the company enters the lemonade business, its iced tea sales are expected to fall 0 percent as some consumers switch from iced tea to lemonade. b. Two years ago the company spent 6- million to renovate a building for a proposed pro#ect that was never undertaken. /f the pro#ect is adopted, the plan is to have the lemonade produced in this building. c. /f the company doesn$t produce lemonade, it can lease the building to another company and receive after+tax cash flows of 6077,777 a year. d. tatements a and c are correct. e. !ll of the statements above are correct.
#ncremental cash flows

"4
Answer: d
Diff: "
Which of the following constitutes an example of a cost that is not incremental, and therefore, not relevant in a capital budgeting decision? a. ! firm has a parcel of land that can be used for a new plant site, or alternatively, can be used to grow watermelons. b. ! firm can produce a new cleaning product that will generate new sales, but some of the new sales will be from customers who switch from another product the company currently produces. c. ! firm orders and receives a piece of new e=uipment that is shipped across the country and re=uires 6"0,777 in installation and set+up costs. d. tatements a, b, and c are examples of incremental cash flows, and therefore, relevant cash flows.
Chapter 11 - Page 9
e. 'one of the statements above is an example of an incremental cash flow. #ncremental cash flows
"8
Answer: d
Diff: "
Which of the following is not considered a relevant concern in deter+ mining incremental cash flows for a new product? a. The use of factory floor space that is currently unused but available for production of any product. b. Devenues from the existing product that would be lost as a result of some customers switching to the new product. c. hipping and installation costs associated with preparing the machine to be used to produce the new product. d. The cost of a product analysis completed in the previous tax year and specific to the new product. e. 'one of the statements above. *!ll of the statements above are relevant concerns in estimating relevant cash flows attributable to a new product.,
Cash flow estimation

"9
Answer: b
Diff: "
Which of the following rules are essential to successful cash flow estimates, and ultimately, to successful capital budgeting analysis? a. The return on invested capital is the only relevant cash flow. b. &nly incremental cash flows are relevant to the acceptJre#ect decision. c. Total cash flows are relevant to capital budgeting analysis and the acceptJre#ect decision. d. tatements a and b are correct. e. !ll of the statements above are correct.
Cash flow estimation

-7
Answer: d
Diff: "
Which of the following statements is correct? a. /n a capital budgeting analysis where part of the funds used to finance the pro#ect are raised as debt, failure to include interest expense as a cost in the cash flow statement when determining the pro#ect$s cash flows will lead to an upward bias in the '(). b. The preceding statement would be true if KupwardL were replaced with Kdownward.L c. The existence of KexternalitiesL reduces the '() to a level below the value that would exist in the absence of externalities. d. /f one of the assets to be used by a potential pro#ect is already owned by the firm, and if that asset could be leased to another firm if the new pro#ect were not undertaken, then the net rent that could be obtained should be charged as a cost to the pro#ect under consideration. e. The rent referred to in statement d is a sunk cost, and as such it should be ignored.
Chapter 11 - Page 10
Corporate risk
-1
Answer: e
Diff: "
/n theory, the decision maker should view market risk as being of primary importance. :owever, within+firm, or corporate, risk is relevant to a firm$s a. Well+diversified stockholders, because it may affect debt capacity and operating income. b. ?anagement, because it affects #ob stability. c. Creditors, because it affects the firm$s credit worthiness. d. tatements a and c are correct. e. !ll of the statements above are correct.
ensitivity! scenario! and simulation analyses

-"
Answer: a
Diff: "
Which of the following statements is correct? a. b. ensitivity analysis is incomplete because it fails to consider the range of likely values of key variables as reflected in their probability distributions. /n comparing two pro#ects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable, such as unit sales, would produce only a small error in the pro#ect$s '(). The primary advantage of simulation analysis over scenario analysis is that scenario analysis re=uires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done using a (C with a spreadsheet program or even a calculator. ensitivity analysis is a risk analysis techni=ue that considers both the sensitivity of '() to changes in key variables and the likely range of variable values. tatements c and d are correct. Answer: e Diff: "
c.
d. e.
"onte Carlo simulation

--
?onte Carlo simulation a. Can be useful for estimating a pro#ect$s stand+alone risk. b. /s capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable. c. (roduces both an expected '() *or /DD, and a measure of the riskiness of the '() or /DD. d. tatements a and b are correct. e. !ll of the statements above are correct.
Risk adjustment
-.
Answer: a
Diff: "
The &neonta Chemical Company is evaluating two mutually exclusive pollution control systems. ince the company$s revenue stream will not be affected by the choice of control systems, the pro#ects are being evaluated by finding the () of each set of costs. The firm$s re=uired rate of return is 1- percent, and it adds or subtracts - percentage points to ad#ust for pro#ect risk differences. ystem ! is #udged to be a high+risk pro#ect because it might cost much more to operate than is expected. ystem !$s risk+ad#usted cost of capital is a. 17 percentG this might seem illogical at first but it correctly ad#usts for risk, when outflows rather than inflows are being discounted. b. 1- percentG the firm$s cost of capital should not be ad#usted when evaluating outflow+only pro#ects. c. 12 percentG since ! is more risky, its cash flows should be discounted at a higher rate because this correctly penali@es the pro#ect for its high risk. d. omewhere between 17 percent and 12 percent, with the answer depending on the riskiness of the relevant inflows. e. /ndeterminate, or, more accurately, irrelevant, because for such pro#ects we would simply select the process that meets the re=uirements with the lowest re=uired investment.
Multiple Choice: P+o,lems Easy:

$a%es on gain on sale
-0
Answer: b
Diff: E
t. Mohn$s (aper is considering purchasing e=uipment today that has a depreciable cost of 61 million. The e=uipment will be depreciated on a ?!CD 0+year basis, which implies the following depreciation schedule3 ?!CD Fepreciation Dates 7."7 7.-" 7.19 7.1" 7.11 7.72
Cear 1 " . 0 2
!ssume that the company sells the e=uipment after three years for 6.77,777 and the company$s tax rate is .7 percent. What would be the tax conse=uences resulting from the sale of the e=uipment? a. b. c. d. e. There are no tax conse=uences. The company would have to pay 6..,777 in taxes. The company would have to pay 6127,777 in taxes. The company would receive a tax credit of 61".,777. The company would receive a tax credit of 6.8,777.
#nventory and N&'

-2
Answer: d
Diff: E
Do#as Computing is developing a new software system for one of its clients. The system has an up+front cost of 640 million *at t E 7,. The client has forecasted its inventory levels for the next five years as shown below3 Cear 1 " . 0 /nventory 61.7 billion 1." billion 1.2 billion ".7 billion "." billion
Do#as forecasts that its new software will enable its client to reduce inventory to the following levels3 Cear 1 " . 0 /nventory 67.8 billion 1.7 billion 1.. billion 1.4 billion 1.9 billion
!fter Cear 0, the software will become obsolete, so it will have no further impact on the client$s inventory levels. Do#as$ client is evaluating this software pro#ect as it would any other capital budgeting pro#ect. The client estimates that the weighted average cost of capital for the software system is 17 percent. What is the estimated '() *in millions of dollars, of the new software system? a. b. c. d. e. 6"--.02 6.89.98 62"0.1" 681-.00 6902..Answer: c Diff: E
N&' with e%ternalities

-4
1llison (roducts is considering a new pro#ect that develops a new laundry detergent, W&W. The company has estimated that the pro#ect$s '() is 6million, but this does not consider that the new laundry detergent will reduce the revenues received on its existing laundry detergent products. pecifically, the company estimates that if it develops W&W the company will lose 6077,777 in after+tax cash flows during each of the next 17 years because of the cannibali@ation of its existing products. 1llison$s W!CC is 17 percent. What is the net present value *'(), of undertaking W&W after considering externalities? a. 6",9"4,412.77 b. 6-,777,777.77 c. +6 4","8-.00 d. 6",874,""8.77 Chapter 11 - Page 13
Medium:
e. +6-,74","8-.00 Answer: c Diff: " N
After(ta% salvage value

-8
%or a new pro#ect, !rmstead /nc. had planned on depreciating new machinery that costs 6-77 million on a .+year, straight+line basis. uppose now, that !rmstead decides to depreciate the new machinery on an accelerated basis according to the following depreciation schedule3 ?!CD Fepreciation Dates "7H -" 19 1" 11 2
Cear 1 " . 0 2
The pro#ect for which the machinery has been purchased ends in four years, and as a result the machinery is going to be sold at its salvage value of 607,777,777. >nder this accelerated depreciation method, what is the after+tax cash flow expected to be generated by the sale of the e=uipment in Cear .? !ssume the firm$s tax rate is .7 percent. a. b. c. d. e. 6-1,877,777 6.1,277,777 607,.77,777 601,277,777 64","77,777 Answer: e Diff: "
New project N&'

-9
;iven the following information, calculate the '() of a proposed pro#ect3 Cost E 6.,777G estimated life E - yearsG initial decrease in accounts receivable E 61,777, which must be restored at the end of the pro#ect$s lifeG estimated salvage value E 61,777G earnings before taxes and depreciation E 6",777 per yearG tax rate E .7 percentG and cost of capital E 18 percent. The applicable depreciation rates are -percent, .0 percent, 10 percent, and 4 percent. a. 61,1-4 b. +6 101 c. 6 1-4 d. 6 87. e. 6 0..
New project N&'

.7
Answer: d
Diff: "
?ars /nc. is considering the purchase of a new machine that will reduce manufacturing costs by 60,777 annually. ?ars will use the ?!CD accelerated method to depreciate the machine, and it expects to sell the machine at the end of its 0+year operating life for 617,777. The firm expects to be able to reduce net operating working capital by 610,777 when the machine is installed, but re=uired net operating working capital will return to its original level when the machine is sold after 0 years. ?ars$ marginal tax rate is .7 percent, and it uses a 1" percent cost of capital to evaluate pro#ects of this nature. The applicable depreciation rates are "7 percent, -" percent, 19 percent, 1" percent, 11 percent, and 2 percent. /f the machine costs 627,777, what is the pro#ect$s '()? a. b. c. d. e. +610,-9. +61.,79+608,01" +6"1,.9+6.2,971 Answer: b Diff: "
New project N&'

.1
tanton /nc. is considering the purchase of a new machine that will reduce manufacturing costs by 60,777 annually and increase earnings before depreciation and taxes by 62,777 annually. tanton will use the ?!CD method to depreciate the machine, and it expects to sell the machine at the end of its 0+year operating life for 617,777 before taxes. tanton$s marginal tax rate is .7 percent, and it uses a 9 percent cost of capital to evaluate pro#ects of this type. The applicable depreciation rates are "7 percent, -" percent, 19 percent, 1" percent, 11 percent, and 2 percent. /f the machine$s cost is 6.7,777, what is the pro#ect$s '()? a. b. c. d. e. 61,71. 6","9" 64,007 6 814 60,7.7
New project N&'

."
Answer: a
Diff: "
?aple ?edia is considering a proposal to enter a new line of business. /n reviewing the proposal, the company$s C%& is considering the following facts3 The new business will re=uire the company to purchase additional fixed assets that will cost 6277,777 at t E 7. %or tax and accounting purposes, these costs will be depreciated on a straight+ line basis over three years. *!nnual depreciation will be 6"77,777 per year at t E 1, ", and -., !t the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of 6177,777. The pro#ect will re=uire a 607,777 increase in net operating working capital at t E 7, which will be recovered at t E -. The company$s marginal tax rate is -0 percent. The new business is expected to generate 6" million in sales each year *at t E 1, ", and -,. The operating costs excluding deprecia+ tion are expected to be 61.. million per year. The pro#ect$s cost of capital is 1" percent. What is the pro#ect$s net present value *'(),? a. b. c. d. e. 60-2,294 6 82,880 6 81,".6 02,--1 6021,279
New project N&'

.-
Answer: b
Diff: "
?acFonald (ublishing is considering entering a new line of business. /n analy@ing the potential business, their financial staff has accumulated the following information3 The new business will re=uire a capital expenditure of 60 million at t E 7. This expenditure will be used to purchase new e=uipment. This e=uipment will be depreciated according to the following depreciation schedule3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74
Cear 1 " .
The e=uipment will have no salvage value after four years. /f ?acFonald goes ahead with the new business, inventories will rise by 6077,777 at t E 7, and its accounts payable will rise by 6"77,777 at t E 7. This increase in net operating working capital will be recovered at t E .. The new business is expected to have an economic life of four years. The business is expected to generate sales of 6- million at t E 1, 6. million at t E ", 60 million at t E -, and 6" million at t E .. 1ach year, operating costs excluding depreciation are expected to be 40 percent of sales. The company$s tax rate is .7 percent. The company$s weighted average cost of capital is 17 percent. The company is very profitable, so any accounting losses on this pro#ect can be used to reduce the company$s overall tax burden. What is the expected net present value *'(), of the new business? a. b. c. d. e. 6 4.7,"98 +61,402,9"9 +61,8--,4". +61,921,8-N60,919,94.
New project N&'

..
Answer: a
Diff: "
Dio ;rande 5ookstores is considering a ma#or expansion of its business. The details of the proposed expansion pro#ect are summari@ed below3 The company will have to purchase 6077,777 in e=uipment at t E 7. This is the depreciable cost. The pro#ect has an economic life of four years. The cost can be depreciated on a ?!CD -+year basis, which implies the following depreciation schedule3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74
Cear 1 " .
!t t E 7, the pro#ect re=uires that inventories increase by 607,777 and accounts payable increase by 617,777. The change in net operating working capital is expected to be fully recovered at t E .. The pro#ect$s salvage value at the end of four years is expected to be 67. The company forecasts that the pro#ect will generate 6877,777 in sales the first two years *t E 1 and ", and 6077,777 in sales during the last two years *t E - and .,. 1ach year the pro#ect$s operating costs excluding depreciation are expected to be 27 percent of sales revenue. The company$s tax rate is .7 percent. The pro#ect$s cost of capital is 17 percent. What is the net present value *'(), of the proposed pro#ect? a. 6109,1.0 b. 61-.,"88 c. 612",814 d. 6107,442 e. +6"04,727
New project N&'

.0
Answer: b
Diff: "
Cour company is considering a machine that will cost 61,777 at Time 7 and can be sold after - years for 6177. To operate the machine, 6"77 must be invested at Time 7 in inventoriesG these funds will be recovered when the machine is retired at the end of Cear -. The machine will produce sales revenues of 6977 per year for - years and variable operating costs *excluding depreciation, will be 07 percent of sales. &perating cash inflows will begin 1 year from today *at Time 1,. The machine will have depreciation expenses of 6077, 6-77, and 6"77 in Cears 1, ", and -, respectively. The company has a .7 percent tax rate, enough taxable income from other assets to enable it to get a tax refund from this pro#ect if the pro#ect$s income is negative, and a 17 percent cost of capital. /nflation is @ero. What is the pro#ect$s '()? a. b. c. d. e. 6 2.". 6 4.89 6 8.84 6 9.10 617..1 Answer: a Diff: "
New project N&'

.2
Cour company is considering a machine that will cost 607,777 at Time 7 and that can be sold after - years for 617,777. 61",777 must be invested at Time 7 in inventories and receivablesG these funds will be recovered when the operation is closed at the end of Cear -. The facility will produce sales revenues of 607,777 per year for - years and variable operating costs *excluding depreciation, will be .7 percent of sales. 'o fixed costs will be incurred. &perating cash inflows will begin 1 year from today *at t E 1,. 5y an act of Congress, the machine will have depreciation expenses of 6.7,777, 60,777, and 60,777 in Cears 1, ", and -, respectively. The company has a .7 percent tax rate, enough taxable income from other assets to enable it to get a tax refund on this pro#ect if the pro#ect$s income is negative, and a 10 percent cost of capital. /nflation is @ero. What is the pro#ect$s '()? a. b. c. d. e. 6 4,24-.41 61",801.40 614,.-2.8. 6".,989.24 6-",48.."0
New project N&'

.4
Answer: d
Diff: "
. 5uckeye 5ooks is considering opening a new production facility in Toledo, &hio. /n deciding whether to proceed with the pro#ect, the company has accumulated the following information3 The estimated up+front cost of constructing the facility at t E 7 is 617 million. %or tax purposes the facility will be depreciated on a straight+line basis over 0 years. The company plans to operate the facility for . years. /t estimates today that the facility$s salvage value at t E . will be 6- million. /f the facility is opened, 5uckeye will have to increase its inventory by 6" million at t E 7. /n addition, its accounts payable will increase by 61 million at t E 7. The company$s net operating working capital will be recovered at t E .. /f the facility is opened, it will increase the company$s sales by 64 million each year for the . years that it will be operated *t E 1, ", -, and .,. The operating costs *excluding depreciation, are expected to e=ual 6- million a year. The company$s tax rate is .7 percent. The pro#ect$s cost of capital is 1" percent.
What is the pro#ect$s net present value *'(),? a. b. c. d. e. 67."8 67.07 67.261.71 61."2 million million million million million
New project N&'

.8
Answer: e
Diff: "
5urress 5everages is considering a pro#ect where they would open a new facility in eattle, Washington. The company$s C%& has assembled the following information regarding the proposed pro#ect3 /t would cost 6077,777 today *at t E 7, to construct the new facility. The cost of the facility will be depreciated on a straight+ line basis over five years. /f the company opens the facility, it will need to increase its inventory by 6177,777 at t E 7. 647,777 of this inventory will be financed with accounts payable. The C%& has estimated that the pro#ect will generate the following amount of revenue over the next three years3 Cear 1 Cear " Cear Devenue E 61.7 million Devenue E 61." million Devenue E 61.0 million
&perating costs excluding depreciation e=ual 47 percent of revenue. The company plans to abandon the facility after three years. !t t E -, the pro#ect$s estimated salvage value will be 6"77,777. !t t E -, the company will also recover the net operating working capital investment that it made at t E 7. The pro#ect$s cost of capital is 1. percent. The company$s tax rate is .7 percent. What is the pro#ect$s net present value *'(),? a. b. c. d. e. 6 29,"74 6148,9.2 6"82,-21 6147,.06"".,.01
New project N&'

.9
Answer: c
Diff: "
?ills ?ining is considering an expansion pro#ect. has the following features3
The proposed pro#ect
The pro#ect has an initial cost of 6077,777. This is also the amount that can be depreciated using the following depreciation schedule3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74
Cear 1 " .
/f the pro#ect is undertaken, at t E 7 the company will need to increase its inventories by 607,777, and its accounts payable will rise by 617,777. This net operating working capital will be recovered at the end of the pro#ect$s life *t E .,. /f the pro#ect is undertaken, the company will reali@e an additional 6277,777 in sales over each of the next four years *t E 1, ", -, and .,. The company$s operating costs *not including depreciation, will e=ual 6.77,777 a year. The company$s tax rate is .7 percent. !t t E ., the pro#ect$s economic life is complete, but it will have a salvage value *before+tax, of 607,777. The pro#ect$s W!CC is 17 percent. The company is very profitable, so any accounting losses on this pro#ect can be used to reduce the company$s overall tax burden. What is the pro#ect$s net present value *'(),? a. b. c. d. e. 611,1"".84 607,--7.1. 60.,242.09 628,--2.82 687,7-0.0"
New project #RR

07
Answer: b
Diff: "
!s one of its ma#or pro#ects for the year, teinbeck Fepot is considering opening up a new store. The company$s C%& has collected the following information, and is proceeding to evaluate the pro#ect. The building would have an up+front cost *at t E 7, of 61. million. %or tax purposes, this cost will be depreciated over seven years using straight+line depreciation. The store is expected to remain open for five years. !t t E 0, the company plans to sell the store for an estimated pre+tax salvage value of 68 million. The pro#ect also re=uires the company to spend 60 million in cash at t E 7 to purchase additional inventory for the store. !fter purchasing the inventory, the company$s net operating working capital will remain unchanged until t E 0. !t t E 0, the company will be able to fully recover this 60 million. The store is expected to generate sales revenues of 610 million per year at the end of each of the next five years. &perating costs *excluding depreciation, are expected to be 617 million per year. The company$s tax rate is .7 percent.
What is the pro#ect$s internal rate of return */DD,? a. b. c. d. e. 10.-0H 1-.9.H 17.2.H 1"..0H -.27H
Risk(adjusted N&'
01
Answer: c
Diff: "
(arker (roducts manufactures a variety of household products. The company is considering introducing a new detergent. The company$s C%& has collected the following information about the proposed product. *'ote3 Cou may or may not need to use all of this information, use only relevant information., The pro#ect has an anticipated economic life of . years. The company will have to purchase a new machine to produce the detergent. The machine has an up+front cost *t E 7, of 6" million. The machine will be depreciated on a straight+line basis over . years *that is, the company$s depreciation expense will be 6077,777 in each of the first four years *t E 1, ", -, and .,. The company anticipates that the machine will last for four years, and that after four years, its salvage value will e=ual @ero. /f the company goes ahead with the proposed product, it will have an effect on the company$s net operating working capital. !t the outset, t E 7, inventory will increase by 61.7,777 and accounts payable will increase by 6.7,777. !t t E ., the net operating working capital will be recovered after the pro#ect is completed. The detergent is expected to generate sales revenue of 61 million the first year *t E 1,, 6" million the second year *t E ",, 6" million the third year *t E -,, and 61 million the final year *t E .,. 1ach year the operating costs *not including depreciation, are expected to e=ual 07 percent of sales revenue. The company$s interest expense each year will be 6177,777. The new detergent is expected to reduce the after+tax cash flows of the company$s existing products by 6"07,777 a year *t E 1, ", -, and .,. The company$s overall W!CC is 17 percent. :owever, the proposed pro#ect is riskier than the average pro#ect for (arkerG the pro#ect$s W!CC is estimated to be 1" percent. The company$s tax rate is .7 percent.
What is the net present value of the proposed pro#ect? a. b. c. d. e. +6 420,97-.94 +61,772,209.08 +6 8".,.18.2" +6 8-8,994.89 +6 448,08-..-
Risk(adjusted N&'
0"
Answer: a
Diff: "
)irus topper /nc., a supplier of computer safeguard systems, uses a cost of capital of 1" percent to evaluate average+risk pro#ects, and it adds or subtracts " percentage points to evaluate pro#ects of more or less risk. Currently, two mutually exclusive pro#ects are under consideration. 5oth have a cost of 6"77,777 and will last . years. (ro#ect !, a riskier+than+ average pro#ect, will produce annual end+of+year cash flows of 641,17.. (ro#ect 5, a less+than+average+risk pro#ect, will produce cash flows of 61.2,.11 at the end of Cears - and . only. )irus topper should accept a. b. c. d. e. 5 with 5oth ! 5 with ! with ! with a '() and 5 a '() a '() a '() of 617,771. because both have '()s greater than @ero. of 68,7.". of 64,144. of 610,928. Answer: e Diff: "
Risk(adjusted N&'
0-
!n all+e=uity firm is analy@ing a potential pro#ect that will re=uire an initial, after+tax cash outlay of 607,777 and after+tax cash inflows of 62,777 per year for 17 years. /n addition, this pro#ect will have an after+tax salvage value of 617,777 at the end of Cear 17. /f the risk+free rate is 2 percent, the return on an average stock is 17 percent, and the beta of this pro#ect is 1.07, what is the pro#ect$s '()? a. 61-,"17 b. 6 .,970 c. 6 4,1"1 d. +6 2,108 e. +61",849
Risk(adjusted N&'
0.
Answer: c
Diff: "
Deal Time ystems /nc. is considering the development of one of two mutually exclusive new computer models. 1ach will re=uire a net investment of 60,777. The cash flows for each pro#ect are shown below3 Cear 1 " (ro#ect ! 6",777 ",077 ","07 (ro#ect 5 6-,777 ",277 ",977
?odel 5, which will use a new type of laser disk drive, is considered a high+risk pro#ect, while ?odel ! is an average+risk pro#ect. Deal Time adds " percentage points to arrive at a risk+ad#usted cost of capital when evaluating high+risk pro#ects. The cost of capital used for average+risk pro#ects is 1" percent. Which of the following statements regarding the '()s for ?odels ! and 5 is most correct? a. b. c. d. '()! '()! '()! '()! E E E E 6 -87G 6 194G 6 -87G 60,-87G '()5 '()5 '()5 '()5 E E E E 61,810 61,097 61,097 62,097 Chapter 11 - Page 25
e. '()! E 6 194G '()5 E 61,810 Risk(adjusted discount rate

00
Answer: b
Diff: "
The >nlimited, a national retailing chain, is considering an investment in one of two mutually exclusive pro#ects. The discount rate used for (ro#ect ! is 1" percent. %urther, (ro#ect ! costs 610,777, and it would be depreciated using ?!CD . /t is expected to have an after+tax salvage value of 60,777 at the end of 2 years and to produce after+tax cash flows *including depreciation, of 6.,777 for each of the 2 years. (ro#ect 5 costs 61.,810 and would also be depreciated using ?!CD . 5 is expected to have a @ero salvage value at the end of its 2+year life and to produce after+tax cash flows *including depreciation, of 60,177 each year for 2 years. The >nlimited$s marginal tax rate is .7 percent. What risk+ ad#usted discount rate will e=uate the '() of (ro#ect 5 to that of (ro#ect !? a. b. c. d. e. 10H 12H 18H "7H 1"H Answer: e Diff: "
Risk(adjusted discount rate

02
California ?ining is evaluating the introduction of a new ore production process. Two alternatives are available. (roduction (rocess ! has an initial cost of 6"0,777, a .+year life, and a 60,777 net salvage value, and the use of (rocess ! will increase net cash flow by 61-,777 per year for each of the . years that the e=uipment is in use. (roduction (rocess 5 also re=uires an initial investment of 6"0,777, will also last . years, and its expected net salvage value is @ero, but (rocess 5 will increase net cash flow by 610,".4 per year. ?anagement believes that a risk+ ad#usted discount rate of 1" percent should be used for (rocess !. /f California ?ining is to be indifferent between the two processes, what risk+ad#usted discount rate must be used to evaluate 5? a. b. c. d. e. 8H 17H 1"H 1.H 12H
Discounting risky outflows

04
Answer: e
Diff: "
!labama (ulp Company *!(C, can control its environmental pollution using either K(ro#ect &ld TechL or K(ro#ect 'ew Tech.L 5oth will do the #ob, but the actual costs involved with (ro#ect 'ew Tech, which uses unproved, new state+of+the+art technology, could be much higher than the expected cost levels. The cash outflows associated with (ro#ect &ld Tech, which uses standard proven technology, are less risky. *They are about as uncertain as the cash flows associated with an average pro#ect., !(C$s cost of capital for average+risk pro#ects is normally set at 1" percent, and the company adds - percent for high+risk pro#ects but subtracts percent for low+risk pro#ects. The two pro#ects in =uestion meet the criteria for high and average risk, but the financial manager is concerned about applying the normal rule to such cost+only pro#ects. Cou must decide which pro#ect to recommend, and you should recommend the one with the lower () of costs. What is the () of costs of the better pro#ect? Cears3 (ro#ect 'ew Tech (ro#ect &ld Tech a. b. c. d. e. +6",0"1 +6",-99 +6",.04 +6",0.+6",."" Answer: c Diff: " Cash &utflows 7 1 " 1,077 -10 -10 277 277 277 -10 277 . -10 277

08
?id+ tate 1lectric Company must clean up the water released from its generating plant. The company$s cost of capital is 17 percent for average+risk pro#ects, and that rate is normally ad#usted up or down by " percentage points for high+ and low+risk pro#ects. Clean+up (lan !, which is of average risk, has an initial cost of +61,777 at Time 7, and its operating cost will be +6177 per year for its 17+year life. (lan 5, which is a high+risk pro#ect, has an initial cost of +6-77, and its annual operating cost over Cears 1 to 17 will be +6"77. What is the proper () of costs for the better pro#ect? a. b. c. d. e. +61,.-7.7. +61,0"0.88 +61,21...2 +61,2.".7" +61,4"8.19

09
Answer: c
Diff: "
Cour company must ensure the safety of its work force. Two plans are being considered for the next 17 years3 *1, /nstall a high electrified fence around the property at a cost of 6177,777. ?aintenance and electricity would then cost 60,777 per year over the 17+year life of the fence. *", :ire security guards at a cost of 6"0,777 paid at the end of each year. 5ecause the company plans to build new head=uarters with a Kstate of the artL security system in 17 years, the plan will be in effect only until that time. Cour company$s cost of capital is 10 percent for average+risk pro#ects, and that rate is normally ad#usted up or down by " percentage points for high+ and low+risk pro#ects. (lan 1 is considered to be of low risk because its costs can be predicted =uite accurately. (lan 5, on the other hand, is a high+risk pro#ect because of the difficulty of predicting wage rates. What is the proper () of costs for the better pro#ect? a. b. c. d. e. +617.,"22."7 +6112,.20.79 +61"-,"9-.7" +61"4,1-1."" +61-0,202.79 Answer: d Diff: "
Risky projects
27
Cochran Corporation has a weighted average cost of capital of 11 percent for pro#ects of average risk. (ro#ects of below+average risk have a cost of capital of 9 percent, while pro#ects of above+average risk have a cost of capital e=ual to 1- percent. (ro#ects ! and 5 are mutually exclusive, whereas all other pro#ects are independent. 'one of the pro#ects will be repeated. The following table summari@es the cash flows, internal rate of return */DD,, and risk of each of the pro#ects. Cear 7 1 " . /DD (ro#ect Disk (ro#ect ! +6"77,777 22,777 22,777 22,777 22,777 1".117H 5elow !verage (ro#ect 5 +6177,777 -7,777 -7,777 .7,777 .7,777 1..7-8H 5elow !verage (ro#ect C +6177,777 -7,777 -7,777 -7,777 .7,777 17.8.8H !verage (ro#ect F +6177,777 -7,777 -7,777 .7,777 07,777 12.2-2H !bove !verage (ro#ect 1 +6177,777 .7,777 "0,777 -7,777 -0,777 11.2-7H !bove !verage
Which pro#ects will the firm select for investment? a. b. c. d. e. (ro#ects3 (ro#ects3 (ro#ects3 (ro#ects3 (ro#ects3 !, 5, 5, !, 5, 5, C, F, 1 C, F, 1 F F C, F
cenario analysis
21
Answer: c
Diff: "
Olott Company encounters significant uncertainty with its sales volume and price in its primary product. The firm uses scenario analysis in order to determine an expected '(), which it then uses in its budget. The base+ case, best+case, and worst+case scenarios and probabilities are provided in the table below. What is Olott$s expected '() *in thousands of dollars,, standard deviation of '() *in thousands of dollars,, and coefficient of variation of '()? (robability of &utcome 7.-7 7.07 7."7 '() '() '() '() '() E E E E E 6-0,777G 6-0,777G 617,-77G 61-,977G 617,-77G '() '() '() '() '() >nit ales )olume 2,777 17,777 1-,777 E E E E E 14,077G 11,224G 1",78-G 8,.42G 1-,977G C)'() C)'() C)'() C)'() C)'() ales (rice 6-,277 .,"77 .,.77 E E E E E ".77 7.-1.14 7.21 1.-0 Answer: a the following four Diff: " N '() */n Thousands, +62,777 P1-,777 P"8,777
Worst case 5ase case 5est case a. b. c. d. e. 1xpected 1xpected 1xpected 1xpected 1xpected
)ptimal project selection

2"
Mackson Corporation is evaluating investment opportunities3 (ro#ect ! 5 C F Cost 6-77,777 107,777 "77,777 .77,777
independent,
Date of Deturn 1.H 17 111
Mackson$s target capital structure is 27 percent debt and .7 percent e=uity. The yield to maturity on the company$s debt is 17 percent. Mackson will incur flotation costs for a new e=uity issuance of 1" percent. The growth rate is a constant 2 percent. The stock price is currently 6-0 per share for each of the 17,777 shares outstanding. Mackson expects to earn net income of 6177,777 this coming year and the dividend payout ratio will be 07 percent. /f the company$s tax rate is -7 percent, which of the pro#ects will be accepted? a. b. c. d. e. (ro#ect ! (ro#ects ! and C (ro#ects !, C, and F !ll of the investment pro#ects will be taken. 'one of the investment pro#ects will be taken.
Tough:
New project N&'
2-
Answer: b
Diff: $
5lair 5ookstores is thinking about expanding its facilities. /n considering the expansion, 5lair$s finance staff has obtained the following information3 The expansion will re=uire the company to purchase today *t E 7, 60 million of e=uipment. The e=uipment will be depreciated over the following four years at the following rate3 Cear Cear Cear Cear 13 "3 -3 .3 --H .0 10 4
The expansion will re=uire the company to increase its net operating working capital by 6077,777 today *t E 7,. This net operating working capital will be recovered at the end of four years *t E .,. The e=uipment is not expected to have any salvage value at the end of four years. The company$s operating costs, excluding depreciation, are expected to be 27 percent of the company$s annual sales. The expansion will increase the company$s dollar sales. The pro#ected increases, all relative to current sales are3 Cear Cear Cear Cear 13 "3 -3 .3 6-.7 -.0 ..0 ..7 million million million million
*%or example, in Cear . sales will be 6. million more than they would have been had the pro#ect not been undertaken., !fter the fourth year, the e=uipment will be obsolete, and will no longer provide any additional incremental sales. The company$s tax rate is .7 percent and the company$s other divisions are expected to have positive tax liabilities throughout the pro#ect$s life. /f the company proceeds with the expansion, it will need to use a building that the company already owns. The building is fully depreciatedG however, the building is currently leased out. The company receives 6-77,777 before+tax rental income each year *payable at year end,. /f the company proceeds with the expansion, the company will no longer receive this rental income. The pro#ect$s W!CC is 17 percent. What is the proposed pro#ect<s '()? a. +61,7-.,842 b. +61,".8,-48 c. +61,089,880
d. +60,.17,0"e. +6 4.8,-48 New project N&'

2.
Answer: d
Diff: $
%oxglove Corp. is faced with an investment pro#ect. information is associated with this pro#ect3
The following
Cear 1 " .
'et /ncomeQ 607,777 27,777 47,777 27,777
?!CD Fepreciation Dates 7.-7..0 7.10 7.74
Q!ssume no interest expenses and a @ero tax rate. The pro#ect involves an initial investment of 6177,777 in e=uipment that falls in the -+year ?!CD class and has an estimated salvage value of 610,777. /n addition, the company expects an initial increase in net operating working capital of 60,777 that will be recovered in Cear .. The cost of capital for the pro#ect is 1" percent. What is the pro#ect$s net present value? *Dound your final answer to the nearest whole dollar., a. b. c. d. e. 610-,8.7 6109,741 612",.79 6128,27. 618",-.. Answer: d Diff: $
New project N&'

20
(ierce (roducts is deciding whether it makes sense to purchase a new piece of e=uipment. The e=uipment costs 6177,777 *payable at t E 7,. The e=uipment will provide cash inflows before taxes and depreciation of 6.0,777 at the end of each of the next four years *t E 1, ", -, and .,. The e=uipment can be depreciated according to the following schedule3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74
Cear 1 " .
!t the end of four years the company expects to be able to sell the e=uipment for an after+tax salvage value of 617,777. The company is in the .7 percent tax bracket. The company has a weighted average cost of capital of 11 percent. 5ecause there is more uncertainty about the salvage value, the company has chosen to discount the salvage value at 1" percent. What is the net present value *'(), of purchasing the e=uipment? a. 6 9,1.7.48 b. 612,.98.4" Chapter 11 - Page 31
c. 6"7,02.."d. 6"",80-.97 e. 6"8.98".2.
New project N&'

22
Answer: d
Diff: $
Augar /ndustries is considering an investment in a proposed pro#ect that re=uires an initial expenditure of 6177,777 at t E 7. This expenditure can be depreciated at the following annual rates3 ?!CD Fepreciation Dates 7."7 7.-" 7.19 7.1" 7.11 7.72
Cear 1 " . 0 2
The pro#ect has an economic life of six years. The pro#ect$s revenues are forecasted to be 697,777 a year. The pro#ect$s operating costs *not including depreciation, are forecasted to be 607,777 a year. !fter six years, the pro#ect$s estimated salvage value is 617,777. The company$s W!CC is 17 percent, and its corporate tax rate is .7 percent. What is the pro#ect$s net present value *'(),? a. b. c. d. e. 6-1,28. 6--,8.6-.,224 6-8,8.7 6.0,.0Answer: b Diff: $
New project #RR

24
!fter a long drought, the manager of Aong 5ranch %arms is considering the installation of an irrigation system that will cost 6177,777. /t is estimated that the irrigation system will increase revenues by 6"7,077 annually, although operating expenses other than depreciation will also increase by 60,777. The system will be depreciated using ?!CD over its depreciable life *0 years, to a @ero salvage value. The applicable depreciation rates are "7 percent, -" percent, 19 percent, 1" percent, 11 percent, and 2 percent. /f the tax rate is .7 percent, what is the pro#ect$s /DD? a. b. c. d. e. 1".2H +1.-H 1-.7H 17."H +..8H
N&' and risk(adjusted discount rate

28
Answer: e
Diff: $
;arcia (aper is deciding whether to build a new plant. The proposed pro#ect would have an up+front cost *at t E 7, of 6-7 million. The pro#ect$s cost can be depreciated on a straight+line basis over three years. Conse=uently, the depreciation expense will be 617 million in each of the first three years, t E 1, ", and -. 1ven though the pro#ect is depreciated over three years, the pro#ect has an economic life of five years. The pro#ect is expected to increase the company$s sales by 6"7 million. ales will remain at this higher level for each year of the pro#ect *t E 1, ", -, ., and 0,. The operating costs, not including depreciation, e=ual 27 percent of the increase in annual sales. The pro#ect$s interest expense is 60 million per year and the company$s tax rate is .7 percent. The company is very profitable, so any accounting losses on this pro#ect can be used to reduce the company$s overall tax burden. The pro#ect does not re=uire any additions to net operating working capital. The company estimates that the pro#ect$s after+tax salvage value at t E 0 will be 61." million. The pro#ect is of average risk, and, therefore, the C%& has decided to discount the operating cash flows at the company$s overall W!CC of 17 percent. :owever, the salvage value is more uncertain, so the C%& has decided to discount it at 1" percent. What is the net present value *'(), of the proposed pro#ect? a. 611.82 million b. 61..-9 million c. +6"2.7. million d. +61".00 million e. +6 1.18 million
Multiple Part:
(The following information applies to the next four problems.) The president of Deal Time /nc. has asked you to evaluate the proposed ac=uisition of a new computer. The computer$s price is 6.7,777, and it falls in the ?!CD -+year class. The applicable depreciation rates are -- percent, .0 percent, 10 percent, and 4 percent. (urchase of the computer would re=uire an increase in net operating working capital of 6",777. The computer would increase the firm$s before+tax revenues by 6"7,777 per year but would also increase operating costs by 60,777 per year. The computer is expected to be used for three years and then sold for 6"0,777. The firm$s marginal tax rate is .7 percent, and the pro#ect$s cost of capital is 1. percent. New project investment
29
Answer: a
Diff: E
What is the net investment re=uired at t E 7? a. b. c. d. +6.",777 +6.7,777 +6-8,277 +6-4,277
e. +6-2,277 )perating cash flow

47
Answer: e
Diff: "
What is the operating cash flow in Cear "? a. b. c. d. e. 6 9,777 617,".7 611,284 61-,.0612,"77 Answer: a Diff: "
Non(operating cash flows

41
What is the total value of the terminal year non+operating cash flows at the end of Cear -? a. b. c. d. e. 618,1"7 619,777 6"1,777 6"0,777 6"4,777 Answer: c Diff: "
New project N&'

4"
What is the pro#ect$s '()? a. b. c. d. e. 6",2"" 6",876",914 60,41" 62,.-8
(The following information applies to the next four problems.) Cou have been asked by the president of your company to evaluate the proposed ac=uisition of a new special+purpose truck. The truck$s basic price is 607,777, and it will cost another 617,777 to modify it for special use by your firm. The truck falls in the ?!CD -+year class, and it will be sold after three years for 6"7,777. The applicable depreciation rates are -- percent, .0 percent, 10 percent, and 4 percent. >se of the truck will re=uire an increase in net operating working capital *spare parts inventory, of 6",777. The truck will have no effect on revenues, but it is expected to save the firm 6"7,777 per year in before+tax operating costs, mainly labor. The firm$s marginal tax rate is .7 percent. New project investment
4-
Answer: d
Diff: E
What is the net investment in the truck? *That is, what is the Cear 7 net cash flow?, a. b. c. d. +607,777 +60",277 +600,877 +62",777 Chapter 11 - Page 35
e. +620,777 )perating cash flow

4.
Answer: c
Diff: "
What is the operating cash flow in Cear 1? a. b. c. d. e. 614,8"7 618,"0. 619,9"7 6"7,1"1 6"1,4-4 Answer: c Diff: "
Non(operating cash flows

40
What is the total value of the terminal year non+operating cash flows at the end of Cear -? a. b. c. d. e. 617,777 61",777 610,287 612,777 618,777 Answer: a What is its '()? Diff: "
New project N&'

42
The truck$s cost of capital is 17 percent. a. +61,0.4 b. +6 02" c. 6 7 d. 6 02" e. 61,7-.
(The following information applies to the next four problems.) 5ruener Detail is considering opening a new store. /n evaluating the proposed pro#ect the company$s C%& has collected the following information3 /t will cost 617 million to construct the new store. These costs will be incurred at t E 7. These costs will be depreciated on a straight+line basis over the next 17 years. The company will need an additional 60 million of inventory to stock the new store. 6" million of this inventory will be financed with accounts payable, the other 6- million will be paid for in cash. The cost of this net increase in operating working capital will be incurred at t E 7. !ssume that this net operating working capital is fully recovered at t E .. The new store will be open for four years. Furing each of the four years *t E 1, ", -, and ., the store will produce the following financial pro#ections *in millions of dollars,3 t E 1 15/TF! Fepreciation 15/T 4.7 Taxes ".8 'et income Chapter 11 - Page 36 t E " 68.7 1.7 4.7 ".8 .." t E 68.7 1.7 4.7 ".8 .." t E . 68.7 1.7 4.7 ".8 .." 68.7 1.7 .."
5ruener finances its pro#ects with 177 percent e=uityG thus, there is no interest expense. The company has a 17 percent weighted average cost of capital. The company assigns a 4 percent cost of capital for its low+risk pro#ects, a 17 percent cost of capital for its average+risk pro#ects, and a 1percent cost for its above+average risk pro#ects. 5ruener estimates that this new store has average risk, so therefore the proposed pro#ect$s cost of capital is 17 percent. )perating cash flows
44
Answer: e
Diff: E
What are the pro#ect$s after+tax operating cash flows for each of the four years? a. b. c. d. e. 6".8 6-.2 6.." 6..8 60." million million million million million Answer: d Diff: " N

48
The C%& estimates that the store can be sold after four years for 64.0 million. 5ruener$s tax rate is .7 percent. What is the store$s after+ tax salvage value at t E .? a. b. c. d. e. 6..0 62.7 62.2 62.9 64.0 million million million million million Answer: d Diff: " N
New project N&'

49
!ssuming the store is sold after four years for 64.0 million, what is the pro#ect$s net present value *'(),? a. b. c. d. e. 6 2.84 6 4..9 6 4.99 617."0 617.20 million million million million million
cenario analysis
87
Answer: e
Diff: "
!fter taking into account all of the relevant cash flows from the previous =uestion, the company$s C%& has estimated the pro#ect$s '() and has also put together the following scenario analysis3 cenario County taxes increased County taxes unchanged County taxes decreased (rob. of cenario &ccurring "0H 07 "0 1xpected '() 6 0 million 8 million 17 million
&n the basis of the numbers calculated above, the C%& estimates that the standard deviation of the pro#ect$s '() is ".72. The company typically calculates a pro#ect$s coefficient of variation *C), and uses this information to assess the pro#ect$s risk. :ere is the scale that 5ruener uses to evaluate pro#ect risk3 Dange for Coefficient of )ariation *C), C) R 7.7." S C) S 7.C) S 7." &n the basis of this scenario statements is most correct? Disk !ssessment :igh risk !verage risk Aow risk analysis, which of (ro#ect$s W!CC 1"H 17 8 the following
a. The pro#ect$s expected '() is 64.40 million. b. The pro#ect would be classified as an average+risk pro#ect. c. /f the pro#ect were classified as a high+risk pro#ect, the company should go back and recalculate the pro#ect$s '() using the higher cost of capital estimate. d. tatements a and b are correct. e. !ll of the statements above are correct.
(The following information applies to the next two problems.) ?itts 5everage /nc. manufactures and distributes fruit #uice products. ?itts is considering the development of a new prune #uice product. ?itts$ C%& has collected the following information regarding the proposed pro#ect3 The pro#ect can be operated at the company$s Fayton plant, which is currently vacant. The pro#ect will re=uire that the company spend 61 million today *t E 7, to purchase a new machine. %or tax purposes, the e=uipment will be depreciated on a straight+line basis. The company plans to use the machine for all - years of the pro#ect. !t t E -, the e=uipment is expected to have no salvage value. The pro#ect will re=uire a 6"77,777 increase in net operating working capital at t E 7. The cost of the net operating working capital will be fully recovered at t E -. The pro#ect is expected to increase the company$s sales 61 million a year for three years *t E 1, ", and -,. The pro#ect$s annual operating costs *excluding depreciation, are expected to be 27 percent of sales. The company$s tax rate is .7 percent. The company is extremely profitable, so any losses incurred from the prune #uice pro#ect can be used to partially offset taxes paid on the company$s other pro#ects. The pro#ect has a W!CC e=ual to 17 percent. Answer: e Diff: " N
New project N&'

81
What is the pro#ect$s net present value? a. b. c. d. e. +612",2"1 +6109,.2. +61.",7-0 +61-0,"71 +61"1,-1Answer: c Diff: E N

8"
There is a possibility that the company may be forced to end the pro#ect after only the second year. /f forced to end the pro#ect, the company will have to sell its e=uipment. /f it sells its e=uipment after the second year, ?itts expects to sell it for 6.77,777. What is the after+tax salvage value that would be incorporated into the pro#ect$s cash flow analysis? a. b. c. d. e. 6-8-,---.-6-2",....07 6-4-,---.-6-8-,---.-6.77,777.77
(The following information applies to the next two problems.) 5uchol@ 5rands is considering the development of a new ketchup product. The ketchup will be sold in a variety of different colors and will be marketed to young children. /n evaluating the proposed pro#ect, the company has collected the following information3 The company estimates that the pro#ect will last for four years. The company will need to purchase new machinery that has an up+front cost of 6-77 million *incurred at t E 7,. !t t E ., the machinery has an estimated salvage value of 607 million. The machinery will be depreciated on a .+year straight+line basis. (roduction on the new ketchup product will take place in a recently vacated facility that the company owns. The facility is empty and 5uchol@ does not intend to lease the facility. The pro#ect will re=uire a 627 million increase in inventory at t E 7. The company expects that its accounts payable will rise by 617 million at t E 7. !fter t E 7, there will be no changes in net operating working capital, until t E . when the pro#ect is completed, and the net operating working capital is completely recovered. The company estimates that sales of the new ketchup will be 6"77 million each of the next four years. The operating costs, excluding depreciation, are expected to be 6177 million each year. The company$s tax rate is .7 percent. The pro#ect$s W!CC is 17 percent. Answer: e Diff: " N
)perating cash flows

8-
What is the pro#ect$s after+tax operating cash flow the first year *t E 1,? a. b. c. d. e. 6"".0 6.0.7 627.7 64".0 697.7 million million million million million Answer: a Diff: " N
New project N&'

8.
What is the pro#ect$s estimated net present value *'(),? a. b. c. d. e. +617.74 +6"0.9" +6.2..1 +627.74 P6 0.48 million million million million million
&e, Appendi- !!A

Multiple Choice: Conceptual Easy:
N&' and depreciation
80
Answer: c
Diff: E
11!+ . &ther things held constant, which of the following would increase the '() of a pro#ect being considered? a. ! shift from ?!CD to straight+line depreciation. b. ?aking the initial investment in the first year rather spreading it over the first three years. c. ! decrease in the discount rate associated with the pro#ect. d. !n increase in re=uired net operating working capital. e. !ll of the statements above will increase the pro#ect$s '(). than
Medium:
Depreciation cash flows Answer: c Diff: "
11!+82. Which of the following statement completions is incorrect? %or a profitable firm, when ?!CD accelerated depreciation is compared to straight+line depreciation, ?!CD accelerated allowances produce a. :igher depreciation charges in the early years of an asset$s life. b. Aarger cash flows in the earlier years of an asset$s life. c. Aarger total undiscounted profits from the pro#ect over the pro#ect$s life. d. maller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes. e. 'one of the statements above. *!ll of the statements above are correct.,
&e, Appendi- !!.

Multiple Choice: Conceptual Medium:
Replacement cash outflows Answer: d Diff: " 115+84. ;iven the following information, what is the re=uired cash outflow associated with the ac=uisition of a new machineG that is, in a pro#ect analysis, what is the cash outflow at t E 7? (urchase price of new machine /nstallation charge ?arket value of old machine 5ook value of old machine /nventory decrease if new machine is installed !ccounts payable increase if new machine is installed Tax rate Cost of capital a. b. c. d. e. +6 8,987 +6 2,.27 +6 0,"77 +6 2,807 +61",7"7 68,777 ",777 ",777 1,777 1,777 077 -0H 10H
Tough:
Replacement decision
88
Answer: b
Diff: $
115+ . Topsider /nc. is considering the purchase of a new leather+cutting machine to replace an existing machine that has a book value of 6-,777 and can be sold for 61,077. The old machine is being depreciated on a straight+line basis, and its estimated salvage value - years from now is @ero. The new machine will reduce costs *before taxes, by 64,777 per year. The new machine has a -+year life, it costs 61.,777, and it can be sold for an expected 6",777 at the end of the third year. The new machine would be depreciated over its -+year life using the ?!CD method. The applicable depreciation rates are 7.--, 7..0, 7.10, and 7.74. !ssuming a .7 percent tax rate and a cost of capital of 12 percent, find the new machine<s '(). a. +6 ",8"" b. 6 1,208 c. 6 .,027 d. 610,-4. e. 6 9,8"1
Replacement decision
89
Answer: a
Diff: $
115+ . ?eals on Wings /nc. supplies prepared meals for corporate aircraft *as opposed to public commercial airlines,, and it needs to purchase new broilers. /f the broilers are purchased, they will replace old broilers purchased 17 years ago for 6170,777 and which are being depreciated on a straight+line basis to a @ero salvage value *10+year depreciable life,. The old broilers can be sold for 627,777. The new broilers will cost 6"77,777 installed and will be depreciated using ?!CD over their 0+year class lifeG they will be sold at their book value at the end of the fifth year. The applicable depreciation rates are 7."7, 7.-", 7.19, 7.1", 7.11, and 7.72. The firm expects to increase its revenues by 618,777 per year if the new broilers are purchased, but cash expenses will also increase by 6",077 per year. /f the firm<s cost of capital is 17 percent and its tax rate is -0 percent, what is the '() of the broilers? a. +627,2.. b. 614,94" c. 6"8,.01 d. +6..,00e. 6 0,7"1 Replacement decision Answer: c Diff: $
115+97. ?om<s Cookies /nc. is considering the purchase of a new cookie oven. The original cost of the old oven was 6-7,777G it is now 0 years old, and it has a current market value of 61-,---.--. The old oven is being depreciated over a 17+year life toward a @ero estimated salvage value on a straight+line basis, resulting in a current book value of 610,777 and an annual depreciation expense of 6-,777. The old oven can be used for 2 more years but has no market value after its depreciable life is over. ?anagement is contemplating the purchase of a new oven whose cost is 6"0,777 and whose estimated salvage value is @ero. 1xpected before+tax cash savings from the new oven are 6.,777 a year over its full ?!CD depreciable life. Fepreciation is computed using ?!CD over a 0+year life, and the cost of capital is 17 percent. The applicable depreciation rates are 7."7, 7.-", 7.19, 7.1", 7.11, and 7.72. !ssume a .7 percent tax rate. What is the net present value of the new oven? a. +6",.18 b. +61,4-1 c. 6",2-0 d. 6 12e. 61,4-1
Replacement project #RR

91
Answer: c
Diff: $
115+ . Tech 1ngineering Company is considering the purchase of a new machine to replace an existing one. The old machine was purchased 0 years ago at a cost of 6"7,777, and it is being depreciated on a straight+line basis to a @ero salvage value over a 17+year life. The current market value of the old machine is 61.,777. The new machine, which falls into the ?!CD 0+year class, has an estimated life of 0 years, it costs 6-7,777, and Tech plans to sell the machine at the end of the fifth year for 61,777. The applicable depreciation rates are 7."7, 7.-", 7.19, 7.1", 7.11, and 7.72. The new machine is expected to generate before+tax cash savings of 6-,777 per year. The company<s tax rate is .7 percent. What is the /DD of the proposed pro#ect? a. ..1H b. "."H c. 7.7H d. +1.0H e. +-.-H Replacement project Answer: d Diff: $
115+9". BCT ?anufacturing Corporation currently has production e=uipment that has . years of remaining life. The e=uipment was purchased a year ago at a cost of 617,777. The annual depreciation for this machine is 61,877 and its expected salvage value is 61,777. The e=uipment can be sold today for 68,777. The company has been considering the purchase of a new machine that will replace the existing one. The new e=uipment costs 610,777 and would increase sales *through increased production, by 6",777 per year and decrease operating costs by 61,777 per year. The e=uipment falls into the -+year ?!CD class and will be worthless after . years. The applicable depreciation rates are 7.--, 7..0, 7.10, and 7.74. The company<s tax rate is .7 percent and its cost of capital is 1" percent. 5y how much would the value of the company change if it accepts the replacement pro#ect? a. 6",11".70 b. 6 -18."4 c. +60,884.90 d. 6 00".2" e. 61,.94.91
New project N&'

9-
Answer: d
Diff: $
115+ . %oxglove Corp. is faced with an investment pro#ect. information is associated with this pro#ect3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74
The following
Cear 1 " .
'et /ncomeQ 607,777 27,777 47,777 27,777
Q!ssume no interest expenses and a @ero tax rate. The pro#ect involves an initial investment of 6177,777 in e=uipment that falls in the -+year ?!CD class and has an estimated salvage value of 610,777. /n addition, the company expects an initial increase in net working capital of 60,777 which will be recovered in year .. The cost of capital for the pro#ect is 1" percent. What is the pro#ect$s net present value? the nearest whole dollar., a. b. c. d. e. 610-,8.7 6109,741 612",.79 6128,27. 618",-.. *Dound your final answer to
A("&E CHAPTE " A(D "%$/T'%(" !!
1*
Relevant cash flows
Answer: d
Diff: E
tatements a and c are trueG therefore, statement d is the correct answer. 'et cash flow E 'et income P depreciationG therefore, depreciation affects operating cash flows. unk costs should be disregarded when making investment decisions, while opportunity costs should be considered when making investment decisions, as they represent the best alternative use of an asset. "* Relevant cash flows Answer: c Diff: E
The correct answer is c. unk costs should be excluded from the analysis, and interest expense is incorporated in the W!CC so it should not be incorporated in the pro#ect$s cash flows. -* Relevant cash flows Answer: d Diff: E
unk costs should be ignored, but externalities and opportunity costs should be included in the pro#ect evaluation. Therefore, the correct choice is statement d. .* Relevant cash flows Answer: b Diff: E
unk costs are never included in pro#ect cash flows, so statement a is false. 1xternalities are always included, so statement b is true. ince the weighted average cost of capital includes the cost of debt, and this is the discount rate used to evaluate pro#ect cash flows, interest expense should not be included in pro#ect cash flows. Therefore, statement c is false. 0 * 2* 4* Relevant cash flows Relevant cash flows Relevant cash flows Answer: c Answer: b Answer: d Diff: E N N
Diff: E Diff: E
The correct answer is statement d. tatement a is a sunk cost and should not be included. tatement b is an opportunity cost and should be included. tatement c is an externality and should be included. Therefore, statement d is the correct choice. 8 * Relevant Answer: d cash Diff: E N flows
9.
The correct answer is statement d. tatement c is incorrect because it is a sunk cost. 5oth statements a and b are correct, since statement a impacts expected cash flows and statement b is a relevant opportunity cost. Relevant cash flows Answer: d Diff: E N The correct answer is statement d. tatement a is correct. This represents a future loss in revenue to the firm. tatement b is also correct because the firm needs to consider the best alternative use of the land. tatement c, on the other hand, is '&T correct since it represents a sunk cost. o, tatement d is the correct choice.
17*
Relevant and incremental cash flows
Answer: a
Diff: E
tatement a is trueG the other statements are false. /f the company lost two other accounts with positive '()s, this would obviously be a huge negative when considering the proposed pro#ect. /f the firm has an option to abandon a pro#ect if it is unprofitable, this would make the company more likely to accept the pro#ect. !n option to repeat a pro#ect is a plus not a negative. 11* New project cash flows Answer: a Diff: E N
tatement a is trueG the others are false. Fepreciation cash flows must be considered when calculating operating cash flows. /n addition, externality cash flows should be consideredG however, sunk costs are not included in the analysis. 1"* 1-* 1.* Corporate risk Risk analysis Risk analysis Answer: b Answer: e Answer: c Diff: E Diff: E Diff: E
tatement a is false. tand+alone risk is measured by standard deviation. Therefore, since C$s standard deviation is higher than B$s, C has higher stand+ alone risk than B. tatement b is false. Corporate risk is measured by the correlation of pro#ect cash flows with other company cash flows. Therefore, since C$s cash flows are highly correlated with the cash flows of existing pro#ects, while B$s are not, C has higher corporate risk than B. ?arket risk is measured by beta. Therefore, since B$s beta is greater than C$s, statement c is true. 10* Risk analysis Answer: a Diff: E N
The correct answer is statement a. ince the proposed new pro#ect has a higher standard deviation than the firm$s typical pro#ect, it has more stand+alone risk than the firm$s typical pro#ect. tatement b is incorrectG it will actually lower corporate risk. tatement c is incorrectG we do not know what effect the pro#ect will have on the firm$s market risk. 12* Risk analysis Answer: e Diff: E N
14* 18* 19* "7*
The correct answer is statement e. tatement a comes directly from the first sentence. tatement c comes from the second sentence. tatements b and d follow directly from the third sentence. Accepting risky projects Answer: e Diff: E Risk adjustment Risk and project selection Risk and project selection Answer: b Answer: b Answer: c Diff: E Diff: E Diff: E
Fetermine the re=uired rate of return on each pro#ect. :igh+risk pro#ects must have a higher re=uired rate of return than low+risk pro#ects. The following table shows the re=uired return for each pro#ect on the basis of its risk level. (ro#ect ! 1xpected Deturn 10H Disk :igh De=uired return for the risk level 1"H
5 C F 1
1" 11 9 2
!verage :igh Aow Aow
17 1" 8 8 its
The company will accept all pro#ects whose expected return exceeds re=uired return. Therefore, it will accept (ro#ects !, 5, and F. "1* ensitivity! scenario! and simulation analyses Answer: c Diff: E
tatement a is falseG sensitivity analysis measures a pro#ect$s stand+alone risk. tatement b is falseG sensitivity analysis doesn$t consider probabilities, while scenario analysis does. tatement c is true. ""* "-* Cash flows and accounting measures Relevant cash flows Answer: d Answer: d Diff: " Diff: "
tatements b and c are trueG therefore, statement d is the correct choice. The 6- million spent on researching the technology is a sunk cost and should not be considered in the investment decision. ".* Relevant cash flows Answer: d Diff: "
tatement a is a sunk cost and sunk costs are never included in the capital budgeting analysis. Therefore, statement a is not included. tatement b is an opportunity cost and should be included in the capital budgeting analysis. tatement c is the cannibali@ation of existing products, which will cause the company to forgo cash flows and profits in another division. Therefore, it is included in the capital budgeting analysis. Therefore, the correct answer is statement d.
"0*
Relevant cash flows
Answer: d
Diff: "
tatements b and c are trueG therefore, statement d is the correct choice. The cost of clearing the land is a sunk cost and should not be considered in the analysis. The expected impact of the new store on the existing store should be considered. /n addition, the opportunity to lease the land represents an opportunity cost of opening the new store on the land and should be considered. "2 * Relevant cash flows Answer: d Diff: "
tatements a and c are trueG therefore, statement d is the correct choice. 1xternalities and opportunity costs should be considered in the analysis, while sunk costs should not be included. "4* "8* "9* -7* #ncremental cash flows #ncremental cash flows Cash flow estimation Cash flow estimation Answer: d Answer: d Answer: b Answer: d Diff: " Diff: " Diff: " Diff: "
tatement d is true. The forgone rent is an Kopportunity costL that should be charged to the pro#ect under consideration. 'ote that tatements a and b are false. The cash flows should not consider interest because financial costs are included in the analysis by discounting at the W!CC. /f interest were deducted to find cash flows, then this cost would be Kdouble counted,L and the '() would be downward biased. /gnoring interest when determining cash flows produces no bias in the '() whatsoever. 'ote also that externalities can be either positive or negative++they tend to be negative if the new pro#ect is a substitute for an existing product, but positive if the new pro#ect is complementary to the firm$s other products. -1* -"* --* -.* Corporate risk ensitivity! scenario! and simulation analyses "onte Carlo simulation Risk adjustment Answer: e Answer: a Answer: e Answer: a Diff: " Diff: " Diff: " Diff: "
k! E 1-H + -H E 17H. /f the cash flows are cost+only outflows, and the analyst wants to correctly reflect their risk, the discount rate should be ad#usted downward *in this case by subtracting - percentage points, to make the discounted flows comparatively larger.
-0
$a%es
on
gain
on
sale
Answer: b
Diff: E
When the machine is sold the total accumulated depreciation on it is3 *7."7 P 7.-" P 7.19, 61,777,777 E 6417,777. The book value of the e=uipment is3 61,777,777 + 6417,777 E 6"97,777. The machine is sold for 6.77,777, so the gain is 6.77,777 + 6"97,777 E 6117,777. Taxes are calculated as 6117,777 7.. E 6..,777. -2* #nventory and N&' Answer: d Diff: E N
We are given the up+front cost. The new software system$s cash flows are the annual cash amounts freed up by not having to invest in inventory.
7 1 " . 0 Cears 17H U U U U U U +40,777,777 P"77,777,777 P"77,777,777 P"77,777,777 P-77,777,777 P-77,777,777
'() E +640,777,777 P P
6"77 , 777 , 777 6"77 , 777 , 777 6"77 , 777 , 777 P P " * 1.1, * 1.1, * 1.1,
6-77 , 777 , 777 6-77 , 777 , 777 P . 0 * 1.1, * 1.1,
'() E +640,777,777 P 6181,818,777 P 6120,"89,777 P 6107,"2-,777 P 6"7.,97.,777 P 6182,"42,777 '() E 681-,007,777.
-4*
N&' with e%ternalities tep 13
Answer: c
Diff: E
Calculate the '() of the negative externalities due to the cannibali@ation of existing pro#ects3 1nter the following input data in the calculator3 C%7 E 7G C%1+17 E +077777G / E 17G and then solve for '() E 6-,74","8-.00. Decalculate the new pro#ect$s '() after considering externalities3 P 6-,777,777 + 6-,74","8-.00 E +64","8-.00. After(ta% Answer: c salvage Diff: " N value
tep "3 -8 *
The book value of the machinery at the end of Cear . is 7.14 6-77,777,777 E 601,777,777. The salvage value of the machinery is 607,777,777, so the company has a loss of 607,777,777 + 601,777,777 E 61,777,777. :owever, the firm will receive a tax credit on the sale of the machinery of 7.. 61,777,777 E 6.77,777. o, the after+tax cash flow received from the sale of the machinery is 607,777,777 P 6.77,777 E 607,.77,777.
-9*
New project N&'

Time line3 7 k E 18H 1 U U +-,777 1,4"8 '() E ? " U 1,9"7 - Cears U 1,10"
Answer: e
Diff: "
Fepreciation cash flows3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74 Fepreciable 5asis 6.,777 .,777 .,777 .,777 !nnual Fepreciation 61,-"7 1,877 277 "87 6.,777 1 " -
Cear 1 " .
(ro#ect analysis worksheet3 7 / /nitial outlay 1, Cost ", Fecrease in '&WC -, Total net investment &perating flows3 ., 15T and depreciation 0, &per. income after taxes *line . 7.2, 2, Fepreciation *from table, 4, Tax savings from *6.,777, 1,777 *6-,777, 6",777 1,"77 1,-"7 6",777 1,"77 1,877 6",777 1,"77 277
//
depreciation *line 2 7.., 8, 'et operating cash flows *lines 0 P 4, /// Terminal year cash flows3 9, 1stimated salvage value 17, Tax on salvage value **61,777 + 6"87, 7.., 11, Deturn of '&WC 1", Total termination C%s /) 'et cash flows3 VVVVVV 1-, 'et C%s *6-,777, 'umerical solution3 '() E +6-,777 +
0"8 61,4"8
4"7 61,9"7
".7 61,..7 61,777 *"88, *1,777, *6 "88, VVVVVV 61,10"
VVVVVV 61,4"8
VVVVVV 61,9"7
61, 4"8 61, 9"7 61, 10" + + E 60....2 W 60... " 1.18 *1.18, *1.18,
%inancial calculator solution3 /nputs3 C%7 E +-777G C%1 E 14"8G C%" E 19"7G C%- E 1,10"G / E 18. &utput3 '() E 60....2 60...
.7*
New project N&' Time line3 7 1 U k E 1"H U +.0,777 4,877 '() E ? Fepreciation cash flows3 Cear 1 " . 0 2 " U 17,287 U 4,027 . U 0,887
Answer: d
Diff: "
0 Cears U +1,9"7
?!CD Fepreciation Dates 7."7 7.-" 7.19 7.1" 7.11 7.72
Fepreciable 5asis 627,777 27,777 27,777 27,777 27,777 27,777
!nnual Fepreciation 61",777 19,"77 11,.77 4,"77 2,277 -,277 627,777

. 0
(ro#ect analysis worksheet3

7 1 " /nitial outlay 1, ?achine cost *627,777, ", Fecrease in '&WC 10,777 -, Total net inv. *6.0,777, // &perating cash flows ., 5T Deduction in cost 6 0,777 6 0,777 6 0,777 6 0, !fter+tax dec. in cost -,777 -,777 -,777 2, Feprec. *from table, 1",777 19,"77 11,.77 4, Tax savings deprec. *line 2 7.., .,877 4,287 .,027 8, 'et operating C%s *lines 0 P 4, 6 4,877 617,287 6 4,027 6 /// Terminal year C%s 9, 1stimated salvage value 17, Tax on salvage value X*617,777 + 6-,277,*7..,Y /
0,777 6 0,777 -,777 -,777 4,"77 2,277 ",887 ",2.7
0,887 6 0,2.7 617,777 *",027,
11, 1", /) 'et 1-,
Deturn of '&WC *10,777, Total termination C%s *4,027, C%s VVVVVVV VVVVVVV VVVVVVV VVVVVVV VVVVVVV VVVVVVV 'et C%s *6.0,777, 6 4,877 617,287 6 4,027 6 0,887*6 1,9"7,
'umerical solution3 '() E +6.0,777 +
64, 877 617, 287 64, 027 60, 887 61, 9"7 + + + + " . 0 1.1" *1.1", *1.1", *1.1", *1.1",
E +6"1,.9-.". W +6"1,.9-. %inancial calculator solution3 /nputs3 C%7 E +.0777G C%1 E 4877G C%" E 17287G C%- E 4027G C%. E 0887G C%0 E +19"7G / E 1". &utput3 '() E +6"1,.9-.". +6"1,.9-.
.1*
New project N&' Time line3 7 k E 9H 1 " U U U +.7,777 9,877 11,4"7 '() E ? Fepreciation cash flows3 ?!CD Fepreciation Cear Dates 1 7."7 " 7.-" 7.19 . 7.1" 0 7.11 2 7.72 (ro#ect analysis worksheet3
/
Answer: b U 9,2.7 . U 8,0"7
Diff: "
0 Cears U 10,-"7
Fepreciable 5asis 6.7,777 .7,777 .7,777 .7,777 .7,777 .7,777
!nnual Fepreciation 6 8,777 1",877 4,277 .,877 .,.77 ",.77 6.7,777

. 0
7 /nitial outlay 1, ?achine cost *6.7,777, ", '&WC ++ -, Total net inv. *6.7,777, // &perating cash flows ., /nc. in earnings before deprec. I taxes 6 0, !fter+tax increase in earnings *line . 7.2, 2, 5efore tax reduction in cost 4, !fter tax reduction in cost *line 2 7.., 8, Feprec. *from table, 9, Feprec. tax savings *line 8 7.., 17, 'et operating C%s *lines 0 P 4 P 9, 6 /// Terminal year C%s 11, 1stimated salvage value 1", Tax on salvage value X*617,777 + 6",.77,*7..,Y 1-, Deturn of '&WC 1., Total termination C%s
"
2,777 6 2,777 6 2,777 6 2,777 6 2,777 -,277 0,777 -,777 8,777 -,"77 -,277 0,777 -,777 1",877 0,1"7 -,277 0,777 -,777 4,277 -,7.7 -,277 0,777 -,777 .,877 1,9"7 -,277 0,777 -,777 .,.77 1,427
9,877 611,4"7 6 9,2.7 6 8,0"7 6 8,-27 617,777 *-,7.7, ++ 2,927
/)
'et C%s 10, 'et C%s
VVVVVVV VVVVVVV VVVVVVV VVVVVVV VVVVVVV VVVVVVV *6.7,777, 6 9,877 611,4"7 6 9,2.7 6 8,0"7 610,-"7
'umerical solution3 '() E +6.7,777 +
69, 877 611, 4"7 69, 2.7 68, 0"7 610, -"7 + + + + " . 0 1.79 *1.79, *1.79, *1.79, *1.79,
E 6","91.97 W 6","9". %inancial calculator solution3 /nputs3 C%7 E +.7777G C%1 E 9877G C%" E 114"7G C%- E 92.7G C%. E 80"7G C%0 E 10-"7G / E 9. &utput3 '() E 6","91.97 6","9". New project N&' Answer: a 1=uipment purchase '&WC +6 7 277,777 +07,777 1 "
."*
Diff: " -
ales increase &perating costs Fepreciation &per. inc. before taxes Taxes *-0H, &per. inc. after taxes PFepreciation &perating cash flow Decovery of '&WC 1=uipment sale Taxes on sale VVVVVVVVVVV 'et C%s +6 207,777
6",777,777 1,.77,777 "77,777 6 .77,777 1.7,777 6 "27,777 "77,777 6 .27,777 VVVVVVVVVV 6 .27,777
6",777,777 1,.77,777 "77,777 6 .77,777 1.7,777 6 "27,777 "77,777 6 .27,777 VVVVVVVVVV 6 .27,777
6",777,777 1,.77,777 "77,777 6 .77,777 1.7,777 6 "27,777 "77,777 6 .27,777 07,777 P177,777 +-0,777 6 040,777
.*
'() E +6207,777 P 6.27,777J1.1" P 6.27,777J*1.1"," P 6040,777J*1.1",E +6207,777 P 6.17,41.."9 P 6-22,479.18 P 6.79,"4-.2. E 60-2,294.11 60-2,294. New project N&' Fepreciation cash flows3 Cear 1 " . Cear (ro#ect cost '&WCQ ?!CD Fepreciation Dates 7.-7..0 7.10 7.74 1 Answer: b Diff: "
Fepreciable 5asis 60,777,777 60,777,777 60,777,777 60,777,777 "
!nnual Fepreciation 61,207,777 ","07,777 407,777 -07,777 60,777,777 .
7 +60,777,777 +-77,777
ales 6-,777,777 6.,777,777 &perating costs *40H, ","07,777 -,777,777 Fepreciation 1,207,777 ","07,777 &per. inc. before taxes +6 977,777 +61,"07,777 Taxes *.7H, +-27,777 +077,777 &per. inc. after taxes +6 0.7,777 +6 407,777 (lus3 Fepreciation 1,207,777 ","07,777 &perating C% 61,117,777 61,077,777 Decovery of '&WC 'et C%s +60,-77,777 61,117,777 61,077,777
60,777,777 -,407,777 407,777 6 077,777 "77,777 6 -77,777 407,777 61,707,777 61,707,777
6",777,777 1,077,777 -07,777 6 107,777 27,777 6 97,777 -07,777 6 ..7,777 -77,777 6 4.7,777
Q!n increase in inventories is a use of funds for the company, and an increase in accounts payable is a source of funds for the company. Thus, the change in net operating working capital will be 6"77,777 + 6077,777 E +6-77,777 at time 7.
..
'() E +60,-77,777 P 61,117,777J1.17 P 61,077,777J*1.17," P 61,707,777J*1.17,- P 64.7,777J*1.17,. '() E +60,-77,777 P 61,779,791 P 61,"-9,229 P 6488,881 P 6070,.-7 '() E +61,402,9"9. * New project Answer: a Fepreciation cash flows3 Cear 1 " . ?!CD Fepreciation Dates 7.-7..0 7.10 7.74 1 Fepreciable 5asis 6077,777 077,777 077,777 077,777 " !nnual Fepreciation 6120,777 ""0,777 40,777 -0,777 6077,777 . Diff: "
N&'
(ro#ect cost '&WC
7 *6077,777, *.7,777,
ales &perating costs Fepreciation &per. costs bef. taxes Taxes *.7H, &per. costs after taxes (lus3 Fepreciation Decovery of '&WC 'et C%s *60.7,777, '() E
6877,777 .87,777 120,777 6100,777 2",777 6 9-,777 120,777 VVVVVVVV 6"08,777
6877,777 .87,777 ""0,777 6 90,777 -8,777 6 04,777 ""0,777 VVVVVVVV 6"8",777
6077,777 -77,777 40,777 61"0,777 07,777 6 40,777 40,777 VVVVVVVV 6107,777
6077,777 -77,777 -0,777 6120,777 22,777 6 99,777 -0,777 .7,777 614.,777 P
+60.7,777 P 6"08,777J1.17 P 6"8",777J*1.17, " P 6107,777J*1.17,614.,777J*1.17,. E +60.7,777 P 6"-.,0.0..0 P 6"--,704.80 P 611",294."" P 6118,8...-. E 6109,1...82 6109,1.0. Answer: b 7 *61,777, *"77, 1 " Diff: "
.0*
New project N&' Cost '&WC
ales Costs Fepreciation &per. inc. before taxes Taxes *.7H, &per. inc. after taxes !dd Fepreciation &perating C%s alvage value Tax on ) Decovery of '&WC 'et C%s *61,"77,
6977 .07 077 *6 07, *"7, *6 -7, 077 6.47
6977 .07 -77 6107 27 6 97 -77 6-97
6.47
6-97
6977 .07 "77 6"07 177 6107 "77 6-07 177 *.7, "77 6217
7 k E 17H 1 U U +1,"77 .47
" U -97
- Cears U 217
'() E +61,"77 + .2* E 64.89. New project N&'
6.47 6-97 6217 + + " 1.17 *1.17, *1.17,

Answer: a
" U U
Diff: "
7 k E 10H 1 U U Cost +07,777 ales 607,777 )C "7,777 Fepreciation .7,777 &per. inc. before taxes *617,777, Taxes *.7H, *.,777, &per. inc. after taxes *6 2,777, Fepreciation .7,777 &perating C%s 6-.,777 '&WC *1",777, !T alvage VVVVVVV VVVVVVV 'C%s *62",777, 6-.,777
Cears
607,777 "7,777 0,777 6"0,777 17,777 610,777 0,777 6"7,777 VVVVVVV 6"7,777
607,777 "7,777 0,777 6"0,777 17,777 610,777 0,777 6"7,777 1",777 2,777 6-8,777
'() E +62",777 + .4
6-., 777 6"7, 777 6-8 , 777 + + E 64,24-.41. " 1.10 *1.10, *1.10,
New project N&'
Answer: d
Diff: "
The e=uipment is purchased for 617,777,777 and is depreciated over 0 years. The depreciation table looks like this3 Cear 1 " . 0 traight+Aine Fepreciation Date 1J0 1J0 1J0 1J0 1J0 Fepreciation 6",777,777 ",777,777 ",777,777 ",777,777 ",777,777 5ook )alue 68,777,777 2,777,777 .,777,777 ",777,777 7
'otice that the pro#ect has a life of only . years, while the e=uipment is depreciated over 0 years. !t the end of Cear ., the company sells the e=uipment for 6- million, but its book value is only 6" million. The e=uipment is sold for 61 million more than its book valueG therefore, the firm will be taxed on this 61 million. Conse=uently, at the end of the pro#ect, it receives 6- million for the sale, but it has to pay 6.77,777 in taxes *.7H of 61 million,. 'et operating working capital re=uired at t E 7 will be 61 million. */nventories are a use of working capital, so they increase operating working capital by 6" million. !ccounts payable are a source of operating working capital, so they decrease operating working capital by 61 million. 'et operating working capital increases by 61 million,. Demember that the firm gets this back at t E ..
Cear 7 ales &p. costs Fep$n &per. inc. before taxes Taxes *.7H, &per. inc. after taxes Fep$n &per. cash flow 1=uipment cost *617,777,777, Taxes on sale Change in '&WC *1,777,777, 'et cash flow *611,777,777, 1 6 4,777,777 -,777,777 ",777,777 6 ",777,777 877,777 6 1,"77,777 ",777,777 6 -,"77,777 " 6 4,777,777 -,777,777 ",777,777 6 ",777,777 877,777 6 1,"77,777 ",777,777 6 -,"77,777 6 4,777,777 -,777,777 ",777,777 6 ",777,777 877,777 6 1,"77,777 ",777,777 6 -,"77,777 . 6 4,777,777 -,777,777 ",777,777 6 ",777,777 877,777 6 1,"77,777 ",777,777 6 -,"77,777 -,777,777 *.77,777, 1,777,777 6 2,877,777
6 -,"77,777
6 -,"77,777
6 -,"77,777
'ow, enter the net cash flows into the cash flow register and enter the discount rate, /JCD E 1", and solve for the pro#ect$s '() E 61,774,-8- 61.71 million.
.8*
New project N&' 7 1=uipment outlay +6077,777 Change in '&WC +-7,777 ales &p. costs excl.deprec. *47H, Fepreciation &per. inc. before taxes Taxes *.7H, &per. inc. after taxes !dd back3 Fepreciation &per. cash flows !T salvage value Decovery of '&WC 'et cash flows +60-7,777 1 61,777,777 477,777 177,777 6 "77,777 87,777 6 1"7,777 177,777 6 ""7,777 6 ""7,777
Answer: e " 61,"77,777 8.7,777 177,777 6 "27,777 17.,777 6 102,777 177,777 6 "02,777 6 "02,777
Diff: " 61,077,777 1,707,777 177,777 6 -07,777 1.7,777 6 "17,777 177,777 6 -17,777 "77,777 -7,777 6 0.7,777
C%7 E +0-7777G C%1 E ""7777G C%" E "02777G C%- E 0.7777G /JCD E 1.G and then solve for '() E 6"".,.07.42 6"".,.01. .9* New project N&' ;et the depreciation using the ?!CD table provided 7 1 " Cost *6077,777, '&WC *.7,777, ales 6277,777 6277,777 &perating Cost .77,777 .77,777 Fepreciation 120,777 ""0,777 &per. inc. before taxes 6 -0,777 *6 "0,777, Taxes *.7H, 1.,777 *17,777, &per. inc. after taxes 6 "1,777 *6 10,777, !fter+tax salvage value Deturn of '&WC P Fepreciation VVVVVVVV 120,777 ""0,777 'et C%s *60.7,777, 6182,777 6"17,777 Answer: c Diff: " R
in the =uestion. . 6277,777 .77,777 40,777 61"0,777 07,777 6 40,777 40,777 6107,777 6277,777 .77,777 -0,777 6120,777 22,777 6 99,777 -7,777 .7,777 -0,777 6"7.,777
'ote in year . your 6.7,777 of net operating working capital is recovered plus the after tax salvage value of 6-7,777. 1nter the cash flows into the cash flow register and solve for the '() using the W!CC of 17H. '() E 60.,242.09. 07
New project #RR tep 13
Answer: b
Diff: "
et up a time line in an income statement format to lay out the cash flows3 7 1 " . 0
5uilding '&WC
+61..7 +0.7 610.7 17.7 ".7 6 -.7 1." 6 1.8 ".7 6 -.8 610.7 17.7 ".7 6 -.7 1." 6 1.8 ".7 6 -.8 610.7 17.7 ".7 6 -.7 1." 6 1.8 ".7 6 -.8 610.7 17.7 ".7 6 -.7 1." 6 1.8 ".7 6 -.8 610.7 17.7 ".7 6 -.7 1." 6 1.8 ".7 6 -.8 8.7 +1.2Q 0.7 610."
Devenues &per. costs Fepreciation &per. inc. before taxes Taxes *.7H, &per. inc. after taxes (lus Fepreciation &per. C%s ale of building Taxes on sale Decovery of '&WC 'et cash flows +619.7
6 -.8
6 -.8
6 -.8
6 -.8
Q!t the end of 0 years, the 5) of the building will be 61.,777,777 + *0 6",777,777, E 6.,777,777. The company sells it for 68 millionG however, the 5) is only 6. million. o, the company will have a KprofitL of 6. million, on which it will owe taxes. The taxes owed are calculated as3 Taxes E 7.. 6. million E 61.2 million.
tep "3
olve for the pro#ect$s /DD3 1nter the following data in the calculator3 C%7 E +19G C%1+. E -.8G C%0 E 10."G and then solve for /DD E 1-.9.H. Answer: c Diff: " N
01*
Risk(adjusted N&' */n thousands of dollars,
" /nitial cost+6",777Change in '&WC +177/nitial outlay +",177 ales61,7776",7776",77761,777&perating costs 077 1,777 1,777 077Fepreciation 077 077 077 077&perating income6 7 6 0776 0776 7Taxes *.7H, 7 "77 "77 7&perating income6 76 -776 -776 7Fepreciation 077 077 077 0771xternalities +"07 +"07 +"07 +"07Deturn of '&WC VVVVVVVVVVVVVVVVVVVVVVVVP 177'et cash flow *'C%,+6",1776 "076 0076 0076 -07 1ntering the 'C% amounts into the cash flow register *at 1"H, gives you a '() of +68".,.18.2". . 0"* Risk(adjusted N&'
Time lines3 (ro#ect !3 7 k E 1.H 1 U U C%s! +"77,777 41,17.
Answer: a
Diff: "
" U 41,17.
U 41,17.
. Cears U 41,17.
'()! E ?
(ro#ect 53 7 k E 17H U C%s5 +"77,777 1 U 7 " U 7 U 1.2,.11 . Cears U 1.2,.11
'()5 E ? Calculate re=uired returns on ! and 53 (ro#ect ! :igh risk kDisk ad#usted E 1"H P "H E 1.H.
(ro#ect 5
Aow risk
kDisk ad#usted E 1"H + "H E 17H.
! /nputs3 C%7 E +"77777G C%1 E 4117.G '# E .G / E 1.. &utput3 '()! E 64,142.27 64,144. 5 /nputs3 C%7 E +"77777G C%1 E 7G '# E "G C%" E 1.2.11G '# E "G / E 17. &utput3 '()5 E 617,771..- 617,771. 0-* Risk(adjusted N&'
Time line3 7 1 k E 1"H U U +07,777 2,777 '() E ? " U 2,777
Answer: e
17 Cears U 2,777 17,777 12,777
Diff: "
alvage value
k(ro#ect E 2H P .H*1.0, E 1"H. /nputs3 C%7 E +07777G C%1 E 2777G '# E 9G C%17 E 12777G / E 1"H. &utput3 '() E +61",848.9- +61",849. 0.* Risk(adjusted N&' Time lines3 7 k E 1"H 1 U U C%s! +0,777 ",777 '()! E ? 7 k E 1.H 1 U U C%s5 +0,777 -,777 '()5 E ? (ro#ect !3 (ro#ect 53 " U ",077 " U ",277 - Cears U ","07 - Cears U ",977 Answer: c Diff: "
k!verage risk E 1"H. k:igh risk E 1"H P "H E 1.H.
00*
!3 /nputs3 C%7 E +0777G C%1 E "777G C%" E "077G C%- E ""07G / E 1". &utput3 '() E 6-87."7 6-87. 53 /nputs3 C%7 E +0777G C%1 E -777G C%" E "277G C%- E "977G / E 1.. &utput3 '() E 61,089.21 61,097. Risk(adjusted discount rate Answer: b Time lines3 (ro#ect ! 7 k E 1"H 1 " U U U C%s! +10,777 .,777 .,777 '()! E ? E -,948.48
(ro#ect 5 7 k E ? 1 " U U U C%s5 +1.,810 0,177 0,177 '()5 E '()! E -,948.48
Diff: "
U .,777
2 Cears U .,777 0,777 alvage value Terminal C% E 9,777

. U .,777
0 U .,777
2 Cears U 0,177 7 alvage value Terminal C% E 0,177
Calculate (ro#ect !$s '()3 /nputs3 C%7 E +10777G C%1 E .777G '# E 0G C%" E 9777G / E 1". &utput3 '() E 6-,948.48. To calculate the discount rate at which (ro#ect 5$s '() is e=ual to (ro#ect !$s, calculate (ro#ect 5$s /DD with an initial cash flow *C%7, that is 6-,948.48 greater than its current C%7. C%7 E +61.,810 P *+6-,948.48, E +618,49-.48. 'ow calculate (ro#ect 5$s /DD3
/nputs3 &utput3
C%7 E +1849-.48G C%1 E 0177G '# E 2. /DD E 10.994H 12H.
Check3 Calculate (ro#ect 5$s '() at k E 12H3 /nputs3 C%7 E +1.810G C%1 E 0177G '# E 2. &utput3 '() E 6-,944.10. *Fifference is due to rounding k up to 12H., 02* Risk(adjusted discount rate Time lines3 (ro#ect !3 7 k E 1"H 1 U U C%s! +"0,777 1-,777 '()! E ? E 14,22-.1(ro#ect 53 7 k E ? 1 U U C%s5 +"0,777 10,".4 '()5 E '()! E 14,22-.1-
Answer: e
Diff: "
" U 1-,777
. Cears U 1-,777 0,777 alvage )alue Terminal C% E 18,777

. Cears U 10,".4 7 alvage )alue Terminal C% E E 10,".4 U 10,".4
U 1-,777
" U 10,".4
!3 53 04 *
/nputs3 &utput3 /nputs3 &utput3
C%7 E +"0777G C%1 E 1-777G '# E -G C%" E 18777G / E 1". '()! E 14,22-.1-. C%7 E +."22-.1- *+"0777 P +1422-.1-,G C%1 E 10".4G '# E .. /DD E 12.7H E k. Answer: e
" U +-10 +277 U +-10 +277 . U +-10 +277

7 U C%s'ew Tech +1,077 '()'ew Tech E ? C%s&ld Tech +277 '()&ld Tech E ?
Diff: "
Time line3
1 U +-10 +277
Decogni@e that *1, risky outflows must be discounted at lower rates, and *", since (ro#ect 'ew Tech is risky, it must be discounted at a rate of 1"H + -H E 9H. (ro#ect &ld Tech must be discounted at 1"H. (ro#ect 'ew Tech3 (ro#ect &ld Tech3 08* /nputs3 &utput3 /nputs3 &utput3 C%7 '() C%7 '() E E E E +1077G C%1 E +-10G '# E .G / E 9. +6",0"7.01. +277G C%1 E +277G '# E .G / E 1". +6",.""..1. Answer: c Diff: "
The first thing to note is that risky cash outflows should be discounted at a lower discount rate, so in this case we would discount the riskier (ro#ect 5$s cash flows at 17H + "H E 8H. (ro#ect !$s cash flows would be discounted at 17H. 'ow we would find the () of the costs as follows3 (ro#ect !3 C%7 E +1777G C%1+17 E +177G / E 17.7G and then solve for '() E +
61,21...2. (ro#ect 53 C%7 E +-77G C%1+17 E +"77G / E 8.7G and then solve for '() E +61,2.".7". (ro#ect ! has the lower () of costs. /f (ro#ect 5 had been evaluated with a 1"H cost of capital, its () of costs would have been +61,.-7.7., but that would have been wrong. 09
Discounting risky outflows (lan 13
Answer: c
Diff: "
*Aow Disk, 7 i E 14H 1 17 Cears U U U +177,777 +0,777 +0,777 With a financial calculator input the following3 C%7 E +177777G C%1+17 E +0777G / E 14G and then '()1 E +61"-,"9-.7". *:igh Disk, 7 i E 1-H 1 U U 7 +"0,777
17 Cears U +"0,777
solve
for
(lan "3
With a financial calculator input the following3 C%7 E 7G C%1+17 E +"0777G / E 1-G and then solve +61-0,202.79.
for
'()"
'ote that because we are dealing with cash outflows, the higher+risk pro#ect$s discount rate must be lowered, while the lower+risk pro#ect$s discount rate must be increased. Thus, (lan 1 has the lower costs and should be accepted. 27* Risky projects Answer: d Diff: "
Aook at the '(), /DD, and hurdle rate for each pro#ect3 (ro#ect ! 5 C F 1 :urdle rate 9.77H 9.77H 11.77H 1-.77H 1-.77H '() 61-,8"" 611,998 /DD 1".11H 1..7.H 17.80H 12.2.H 11.2-H '()! E +6"77,777 +
622, 777 622, 777 622, 777 622, 777 + + + E 61-,8"1.01 W 61-,8"". " . 1.79 *1.79, *1.79, *1.79,
'()5 E +6177,777 +
6-7, 777 6-7, 777 6.7, 777 6.7, 777 + + + E 611,994.28 W 611,998. " . 1.79 *1.79, *1.79, *1.79,
(ro#ects ! and 5 are mutually exclusive, so we cannot use the /DD method, so their '()s must be calculated. We pick pro#ect ! because it has the largest '(). (ro#ects C, F, and 1 are independent so we pick the ones whose /DD exceeds the cost of capital, in this case, #ust F. Therefore, the pro#ects undertaken are ! and F. 21
cenario analysis Calculate expected value of '() *in thousands,3

(robability of &utcome, (i Worst case 7.-7 5ase case 7.07 5est case 7."7 >nit ales ales '() )olume (rice */n 1777s, 2,777 6-,277 +62,777 17,777 .,"77 1-,777 1-,777 .,.77 "8,777
Answer: c
Diff: "
(i*x, 7.-*+2,777, 7.0*1-,777, 7."*"8,777, 1xpected '()
E +1,877 E 2,077 E 0,277 E 617,-77
Calculate standard deviation of '() *in thousands,3 (i*x + x ," *x + x ,"

VVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVVV VVVVVVVVVVVVVVVVVVVVVVVVVVV
Worst case 5ase case 5est case
7.-*+2,777 N 17,-77," 7.0*1-,777 N 17,-77," 7."*"8,777 N 17,-77,"
(i*x + x ," "20,297,777 49,474,777 4,"97,777 -,2.0,777 -1-,"97,777 2",208,777 " E 1.2,717,777
VVVVVVVVVVVVVVVVVVVVVVVVVVV
'() E *1.2,717,777,Z E 1",78-. Calculate coefficient of variation *C), of '()3 C)'() E '()J1*'(), E 61",78-J617,-77 E 1.14. 2"* )ptimal project selection Answer: a Diff: " N
Calculate the after+tax component cost of debt as 17H*1 + 7.-, E 4H. /f the company has earnings of 6177,777 and pays out 07H or 607,777 in dividends, then it will retain earnings of 607,777. The retained earnings breakpoint is 607,777J7.. E 61"0,777. ince it will re=uire financing in excess of 61"0,777 to undertake any of the alternatives, we can conclude the firm must issue new e=uity. Therefore, the pertinent component cost of e=uity is the cost of new e=uity. Calculate the expected dividend per share *note this is F 1, as 607,777J17,777 E 60. Thus, the cost of new e=uity is 60JX*6-0*1 + 7.1",Y P 2H E ""."-H. Mackson$s W!CC is 4H*7.2, P ""."-H*7.., E 1-.79H. &nly the return on (ro#ect ! exceeds the W!CC, so only (ro#ect ! will be undertaken.
2-*
New project N&' Fepreciation chedule Fepreciable 5asis3 ?!CD Fepreciation Dates 7.-7..0 7.10 7.74 60,777,777
Answer: b
Diff: $
Cear 1 " .
!nnual Fepreciation 61,207,777 ","07,777 407,777 -07,777
The following table shows how to compute the cash flows3

71"-.Cost*60,777,777,'et operating working capital*077,777, ales6-,777,7776-,077,7776.,077,7776.,777,777&perating costs, excl. depr. *27H, 1,877,777 ",177,777 ",477,777 .07,777,*6 ",.77,777Fepreciation 017,777,6 1,207,777 ","07,777VVVVVVVVVV *187,777, Fepreciation 407,777VVVVVVVVVV *-.7,777, 1,207,777 ."7,777 ","07,777 -07,777&perating income before taxes*6 407,777 807,777,61,707,77761,"07,777Taxes *.7H, 2-7,7776 407,777(lus3
077,777!fter+tax operating income*6
"47,777,*6
-07,777!fter+tax operating cash flows61,-87,77761,4.7,77761,-87,77761,177,777!fter+tax loss of rental income*187,777,*187,777,*187,777,*187,777,Decovery of net operating working capitalVVVVVVVVVVV VVVVVVVVVVVVVVVVVVVV VVVVVVVVVVVVVVVVVVV VVVVVVVVVVVVVVVVVVV VVVVVVVVV6 077,777 077,777'et cash flow*60,077,777,61,"77,77761,027,77761,"77,77761,."7,777
1nter the 'C% amounts into the cash flow register *at 17H, and obtain the '() of the cash flows is +61,".8,-48. 2.* New project N&' tep 13 Calculate depreciation3 Fep1 E 6177,777*7.--, E Fep" E 6177,777*7..0, E Fep- E 6177,777*7.10, E Fep. E 6177,777*7.74, E 6--,777. 6.0,777. 610,777. 6 4,777. E +6170,777. E 6 8-,777. E 6170,777. E 6 80,777. P 60,777 P 610,777 E 684,777. Answer: d Diff: $
tep "3
Calculate cash flows3 C%7 E +6177,777 + 6 0,777 C%1 E 607,777 P 6--,777 C%" E 627,777 P 6.0,777 C%- E 647,777 P 610,777 C%. E 627,777 P 6 4,777
tep -3
Calculate '() with your financial calculator3 C%7 E +170777G C%1 E 8-777G C%" E 170777G C%- E 80777G C%. E 84777G / E 1"G and then solve for '(). '() E 6128,27-.89 6128,27..
20*
New project N&'
Answer: d
Diff: $
%irst, find the after+tax C%s associated with the pro#ect. This is accomplished by subtracting the depreciation expense from the raw C%, reducing this net C% by taxes and then adding back the depreciation expense. %or t E 13 *6.0,777 + 6--,777,*1 + 7.., P 6--,777 E 6.7,"77. imilarly, the after+tax C%s for t E ", t E -, and t E . are 6.0,777, 6--,777, and 6"9,877, respectively. 'ow, enter these C%s along with the cost of the e=uipment to find the pre+ salvage '() *note that the after+tax salvage value is not yet accounted for in these C%s,. The appropriate discount rate for these C%s is 11 percent. This yields a pre+salvage '() of 612,.98.4". %inally, the after+tax salvage value must be discounted. The () of the after+ tax salvage value is calculated as follows3 ' E .G / E 1"G (?T E 7G %) E +17777G and () E 62,-00.18. !dding the () of the after+tax salvage value to the pre+salvage '() yields the pro#ect '() of 6"",80-.97. 22* New project N&' The cash flows for each of the years are as follows3
7 1 " . 0 2 X97,777 + 07,777 + X97,777 + 07,777 + X97,777 + 07,777 + X97,777 + 07,777 + X97,777 + 07,777 + X97,777 + 07,777 + *17,777,*1 + 7.., *177,777,*7."7,Y*1 *177,777,*7.-",Y*1 *177,777,*7.19,Y*1 *177,777,*7.1",Y*1 *177,777,*7.11,Y*1 *177,777,*7.72,Y*1 + + + + + + 7.., 7.., 7.., 7.., 7.., 7.., P P P P P P *177,777,*7."7, *177,777,*7.-", *177,777,*7.19, *177,777,*7.1", *177,777,*7.11, *177,777,*7.72, P E E E E E E +177,777 -",777 -2,877 -1,277 "8,877 "8,.77 -",.77
Answer: d
Diff: $
1nter the cash flows into the cash flow register *at 17H, and solve for the '() E 6-8,8-9.09 6-8,8.7.
24*
New project #RR
Answer: b
Diff: $
Time line3 /DD E ? 7 1 k E 1"H U U +177,777 14,-77 '() E ? " U "",177 U 12,977 . U 1.,177 0 U 1-,477 2 Cears U 11,477
Cear 1 " . 0 2
?!CD Fepreciation Dates 7."7 7.-" 7.19 7.1" 7.11 7.72
Fepreciable 5asis 6177,777 177,777 177,777 177,777 177,777 177,777
!nnual Fepreciation 6"7,777 -",777 19,777 1",777 11,777 2,777 6177,777
(ro#ect analysis worksheet3

7 1 " . 0 2 /nitial outlay 1, ?achine cost *6177,777, ", '&WC ++ -, Total net inv. *6177,777, // &perating cash flows ., /nc. in before taxes I deprec. earnings 610,077 610,077 610,077 610,077 610,077 610,077 0, !fter+tax inc. in revenues *line . 7.2, 9,-77 9,-77 9,-77 9,-77 9,-77 9,-77 2, Feprec. *from table, "7,777 -",777 19,777 1",777 11,777 2,777 4, Feprec. tax savings *line 2 7.., 8,777 1",877 4,277 .,877 .,.77 ",.77 8, 'et operating C%s *lines 0 P 4, 614,-77 6"",177 612,977 61.,177 61-,477 611,477 /// Terminal year C%s 9, 1stimated salvage value 7 17, Tax on salvage value 7 11, Deturn of '&WC 7 1", Total termination C%s 7 /) 'et C%s 1-, 'et C%s *6177,777,614,-77 6"",177 612,977 61.,177 61-,477 611,477 /
%inancial calculator solution3 /nputs3 C%7 E +177777G C%1 E 14-77G C%" E ""177G C%- E 12977G C%. E 1.177G C%0 E 1-477G C%2 E 11477. &utput3 /DD E +1.-"H.
28*
N&' and risk(adjusted discount rate
Answer: e
Diff: $
The following table shows the cash flows *in millions,3 /nitial invest. outlay ales &per. cost Fepreciation 7 +6-7.7 1 6"7.7 1".7 17.7 " 6"7.7 1".7 17.7 6"7.7 1".7 17.7 . 6"7.7 1".7 7.7 0 6"7.7 1".7 7.7
&per. inc. before taxes Taxes *.7H, &per. inc. after taxes !dd Fepreciation 'et oper. cash flows
+6-7.7
+6 ".7 +7.8 +6 1." 17.7 6 8.8
+6 ".7 +7.8 +6 1." 17.7 6 8.8
+6 ".7 +7.8 +6 1." 17.7 6 8.8
6 8.7 -." 6 ..8 7.7 6 ..8
6 8.7 -." 6 ..8 7.7 6 ..8
'umerical solution3 tep 13 Fetermine the '() of net operating cash flows3 '() E +6-7 P 68.8J1.17 P 68.8*1.17," P 68.8J*1.17,P 6..8J*1.17,. P 6..8J*1.17,0 E +6-7 P 68 P 64."4"4 P 62.2112 P 6-."480 P 6".987. E +61.8028 million. tep "3 tep -3 Fetermine the '() of the pro#ect$s !T salvage value3 61."J*1.1",0 E 67.2879 million. Fetermine the pro#ect$s '()3 !dd the () of the salvage value to the '() of the cash flows to get the pro#ect$s '(). '() E +61.8028 P 67.2879 E +61.1409 million +61.18 million.
%inancial calculator solution3 tep 13 Fetermine the '() of net operating cash flows3 1nter the following inputs in the calculator3 C%7 E +-7, C%1+- E 8.8, C%.+0 E ..8, / E 17, and then solve for '() E + 61.8028 million. tep "3 Fetermine the '() of the pro#ect$s !T salvage value3 1nter the following inputs in the calculator3 C%7 E 7, C%1+. E 7, C%0 E 1.", / E 1", and then solve for '() E 67.2879 million. Fetermine the pro#ect$s '()3 !dd the () of the salvage value to the '() of the cash flows to get the pro#ect$s '(). +61.8028 P 67.2879 E +61.1409 million 6+1.18 million.
tep -3
29*
New project investment /nitial investment3 Cost Change in '&WC *6.7,777, *",777, *6.",777,
Answer: a
Diff: E
47 *
)perating cash flow Fepreciation schedule3 ?!CD Fepreciation Dates Fepreciable 5asis
Answer: e
Diff: "
Cear
!nnual Fepreciation
1 " . &perating cash flows3 1, ", -, .,
7.-7..0 7.10 7.74
6.7,777 .7,777 .7,777 .7,777
61-,"77 18,777 2,777 ",877 6.7,777 6"7,777 *0,777, 610,777 6 9,777 2,777 ",.77 611,.77 Answer: a Diff: "
/ncrease in revenues /ncrease in costs 5efore+tax change in earnings !fter+tax change in earnings *line - 7.27, 0, Fepreciation 2, Feprec. tax savings *line 0 7..7, 4, 'et operating C%s *lines . P 2, 41* Non(operating cash flows !dditional Cear - cash flows3 alvage value Tax on alvage value Decovery of '&WC Total terminal year C%
1 6"7,777 *0,777, 610,777 6 9,777 1-,"77 0,"87 61.,"87
" 6"7,777 *0,777, 610,777 6 9,777 18,777 4,"77 612,"77
6"0,777 *8,887,Q ",777 618,1"7
Q*?arket value + 5ook value,*Tax rate, *6"0,777 + 6",877,*7..7, E 68,887.
4"*
New project N&'

Time line3 7 k E 1.H 1 U U +.",777 1.,"87 " U 12,"77 - Cears U 11,.77 T) E 18,1"7 "9,0"7
Answer: c
Diff: "
'umerical solution3 '() E +6.",777 +
61., "87 612, "77 6"9, 0"7 + + E 6",912.80 W 6",914. " 1.1. *1.1., *1.1.,-
%inancial calculator solution3 /nputs3 C%7 E +."777G C%1 E 1."87G C%" E 12"77G C%- E "90"7G / E 1.. &utput3 '() E 6",912.80 6",914.
4-*
New project investment /nitial investment3 Cost ?odification Change in '&WC Total net investment *607,777, *17,777, *",777, *62",777,
Answer: d
Diff: E
4. *
)perating cash flow Fepreciation schedule3 Cear 1 " . ?!CD Fepreciation Dates 7.-7..0 7.10 7.74
Answer: c
Diff: "
Fepreciable 5asis 627,777 27,777 27,777 27,777
!nnual Fepreciation 619,877 "4,777 9,777 .,"77 627,777 " 6"7,777 1",777 "4,777 17,877 6"",877 6"7,777 1",777 9,777 -,277 610,277
40
&perating cash flows3 Cear 1, 5efore+tax cost reduction ", !fter+tax cost reduction *line 1 7.2, -, Fepreciation ., Feprec. tax savings *line - 7.., 0, 'et operating C%s *lines " P .,
1 6"7,777 1",777 19,877 4,9"7 619,9"7
Non(operating cash flows !dditional Cear - cash flows3 alvage value Tax on salvage value Decovery of '&WC Total terminal year C% 6"7,777 *2,-"7,Q ",777 610,287
Answer: c
Diff: "
Q*?arket value + 5ook value,*Tax rate, E *6"7,777 + 6.,"77,*7..7, E 62,-"7. 42 * New project N&'
Time line3 7 k E 17H 1 U U +2",777 19,9"7 " U "",877 - Cears U 10,277 T) E 10,287 -1,"87
Answer: a
Diff: "
'umerical solution3
'() E +62",777 +
619, 9"7 6"" , 877 6-1, "87 + + E +61,0.2.81 W +61,0.4. " 1.17 *1.17, *1.17,
%inancial calculator solution3 /nputs3 C%7 E +2"777G C%1 E 199"7G C%" E ""877G C%- E -1"87G / E 17. &utput3 '() E +61,0.2.81 +61,0.4. 44. )perating cash flows Answer: e Diff: E N
&perating cash flow is 'et income P Fepreciation, which is 60." million. Fepreciation 'et income &per. C%s 48. t E 1 61.7 .." 60." t E " 61.7 .." 60." t E 61.7 .." 60." t E . 61.7 .." 60." Answer: d Diff: " N
The original cost of the store is 617 million and the annual depreciation expense is 61 million *since the store is being depreciated on a straight+ line basis over 17 years,. o after . years the remaining 5) E 617 + 6. E 62 million. /f the store is sold for 64.0 million, the gain on the sale is 64.0 + 62.7 E 61.0 million. The tax on the gain is 7..*61.0, E 67.2 million. The after+tax salvage value is 64.0 + 67.2 E 62.9 million.
49.
New project N&' The relevant cash flows are shown below3 Construction cost '&WC &perating cash flow !T alvage value Total cash flow 'umerical solution3 '() E +61-.7 P t E 7 +617.7 +-.7 +61-.7 t E 1 60." 60." t E " 60." 60."
Answer: d
Diff: "
t E 60." 60."
t E . 6-.7 0." 2.9 610.1
60." 60." 60." 610.1 + + + " . 1.17 *1.17, *1.17, *1.17,
E +61-.7 P 6..4"4- P 6.."940 P 6-.9728 P 617.-1-0 E 617.".0 617."0 million. %inancial calculator solution3 C%7 E +1-G C%1 E 0."G C%" E 0."G C%- E 0."G C%. E 10.1G / E 17G and then solve for '() E 617.".0 617."0 million. 87* cenario analysis Answer: e Diff: " N
The correct answer is statement e. The expected '() for the pro#ect E 7."0 60 P 7.0 68 P 7."0 617 E 64.40 million. Therefore, statement a is correct. The standard deviation of the pro#ect is given as ".72. o, the coefficient of
variation, or C), is 4.40J".72 E 7."208. Thus, the pro#ect falls into the K!verage+riskL category, so statement b is correct. Decall that you discounted cash flows using 17H, which is the weighted average cost of capital for an K!verage+riskL pro#ect. /f the pro#ect were classified as a K:igh+riskL pro#ect, the company should go back and recalculate the pro#ect$s '() using the higher cost of capital estimate of 1"H. o, statement c is also correct. Therefore, statements a, b, and c are correct, and the correct choice is statement e. 81* New project N&' t E 7 1=uipment +61,777,777 'et oper. working capital +"77,777 ales &per. costs *27H, Fepreciation 15/T Taxes *.7H, 15/T*1 + T, Fepreciation !T &per. C% Decovery of '&WC 'et cash flows t E 1 Answer: e t E " Diff: " N
t E -
VVVVVVVVVVV +61,"77,777
61,777,777 277,777 ---,--6 22,224 "2,224 6 .7,777 ---,--6 -4-,--VVVVVVVVVV 6 -4-,---
61,777,777 277,777 ---,--6 22,224 "2,224 6 .7,777 ---,--6 -4-,--VVVVVVVVVV 6 -4-,---
61,777,777 277,777 ---,--6 22,224 "2,224 6 .7,777 ---,--6 -4-,--"77,777 6 04-,---
8"*
1nter the cash flows into the cash flow register *at 17H, and solve for the '() E +61"1,-1-. After(ta% salvage value Answer: c Diff: E N The tax due on the sale of e=uipment would be3 *6.77,777 + 6---,---.--, .7H E 6"2,222.24. Then, subtracting this tax from the sale price, *6.77,777 + 6"2,222.24, you get 6-4-,---.--.
8-*
)perating cash flows
Answer: e
Diff: "
!fter+tax operating C% E 15/T*1 + T, P Fepreciation. Fepreciation expense E 6-77,777,777J. E 640,777,777. %or each year, 15/T E ales + &perating costs N Fepreciation E 6"77,777,777 + 6177,777,777 N 40,777,777 E 6"0,777,777. !fter+tax operating C% E 6"0,777,777*1 N 7.., P 640,777,777 E 610,777,777 P 640,777,777 E 697,777,777. 8.* New project N&' Answer: a Diff: " N
The pro#ect cash flows are shown below *in millions of dollars,3 >p+front costs /ncrease in '&WC ales 7 +-77 +07 1 " .
"77
"77
"77
"77
&perating costs Fepreciation 15/T Taxes *.7H, 15/T*1 + T, Fepreciation &perating C% !T* ), '&WC recovery 'et C%
+177 +40 "0 +17 10 40 97 +-07 97
+177 +40 "0 +17 10 40 97 97
+177 +40 "0 +17 10 40 97 97
+177 +40 "0 +17 10 40 97 -7 07 147
>sing your financial calculator, enter the following data inputs3 C%7 E +-07G C%1+- E 97G C%. E 147G / E 17G and then solve for '() E +617.74 million.
&E. APPE(D'0 !!A "%$/T'%("

80++A(* N&' and depreciation 82++A(* Depreciation cash flows 84 Answer: c Answer: c Diff: E Diff: "
&E. APPE(D'0 !!. "%$/T'%("

++,(* Replacement cash outflows Cost plus installation ale of old machine Tax effect of sale *61,777 7.-., Fecrease in working capital Total investment at t E 7 88 *617,777, ",777 *-07, 1,077 *6 2,807, Answer: d Diff: "
++,(*
Replacement decision Time line3 7 1 k E 12H U U +11,977 0,2.8 '() E ? Fepreciation cash flows3 ?!CD Fepreciation Cear Dates 1 7.-" 7..0 7.10 . 7.74 " U 2,-"7 - Cears U 2,"-"
Answer: b
Diff: $
'ew !sset Fepreciation 6.,2"7 2,-77 ",177 987
&ld !sset Fepreciation 61,777 1,777 1,777 ++
Change in Fepreciation 6-,2"7 0,-77 1,177 987
(ro#ect analysis worksheet3 / /nitial outlay 1, ?achine cost *61.,777, ", ale of old machine 1,077Q -, Tax savings old machine 277 ., Total net inv. *611,977, Q*6-,777 + 61,077, E AossG Aoss Tax rate E avingsG 61,077 7..7 E 6277. // &perating cash flows Cear3 7 1 " 0, Deduction in cost 64,777 64,777 2, !fter+tax decrease in cost *line 0 7.27, .,"77 .,"77 4, Feprec. new machine .,2"7 2,-77 8, Feprec. old machine 1,777 1,777 9, Change in depreciation *line 4 + 8, -,2"7 0,-77 17, Tax savings from deprec. *line 9 7..7, 1,..8 ",1"7 11, 'et operating cash flows *line 2 P 17, 60,2.8 62,-"7 /// Terminal year C%s 1", 1stimated salvage value 1-, Tax on salvage value *",777 + 987,*7.., 1., Deturn of 'WC 10, Total termination C%s
64,777 .,"77 ",177 1,777 1,177 ..7 6.,2.7 6",777 *.78, ++ 1,09"
/)
'et C%s 12, Total 'et Cfs
*611,977, 60,2.8
62,-"7
62,"-"
%inancial calculator solution3 /nputs3 C%7 E +11977G C%1 E 02.8G C%" E 2-"7G C%- E 2"-"G / E 12. &utput3 '() E 61,208.-- 61,208. 89++,(* Replacement decision Answer: a Diff: $
Time line3 7 1 " . 0 Cears k E 17H U U U U U U +1.8,407 "1,2"0 -7,7"0 "7,9"0 12,7"0 "4,-"0 '() E ? Fepreciation cash flowsQ3 ?!CD Fepreciation 'ew !sset &ld !sset Change in Cear Dates Fepreciation Fepreciation Fepreciation 1 7."7 6.7,777 64,777 6--,777 " 7.-" 2.,777 4,777 04,777 7.19 -8,777 4,777 -1,777 . 7.1" ".,777 4,777 14,777 0 7.11 "",777 4,777 10,777 2 7.72 1",777 ++ 1",777 QFepreciation old e=uipment3 170,777J10 E 4,777 per year 17 years E 47,777 in accumulated depreciation. 5ook value E + 6170,777 47,777 6 -0,777
Deplacement analysis worksheet3 / /nitial outlay 1, 'ew e=uipment cost *6"77,777, ", ?arket value old e=uip. 27,777 -, Taxes on sale of old e=uip. *8,407,Q ., /ncrease in 'WC ++ 0, Total net investment *61.8,407, Q*?arket value + 5ook value,*Tax rate, *27,777 + -0,777,*7.-0, E 68,407. // &perating cash flows
Cear3 7 1 " . 0 2, /ncrease in revenues 618,777 618,777 618,777 618,777 618,777 4, /ncrease in expenses *",077, *",077, *",077, *",077, *",077, 8, !T change in earnings **line 2 P 4, 7.20, 17,740 17,740 17,740 17,740 17,740 9, Feprec. on new machine .7,777 2.,777 -8,777 ".,777 "",777 17, Feprec. on old machine 4,777 4,777 4,777 4,777 4,777 11, Change in deprec. *line 9 + 17, --,777 04,777 -1,777 14,777 10,777 1", Tax savings from deprec. *line 11 7.-0, 11,007 19,907 17,807 0,907 0,"07 1-, 'et operating C%s *line 8 P 1", 6"1,2"0 6-7,7"0 6"7,9"0 612,7"0 610,-"0 /// Terminal year C%s 1., 1stimated salvage value 61",777 10, Tax on salvage value ++ 12, Deturn of 'WC ++ 14, Total termination C%s 1",777 /) 'et C%s 18, Total 'et C%s*61.8,407, 6"1,2"0 6-7,7"0 6"7,9"0 612,7"0 6"4,-"0 %inancial calculator solution3 /nputs3 C%7 E +1.8407G C%1 E "12"0G C%" E -77"0G C%- E "79"0G
97++,(* Replacement decision
C%. E 127"0G C%0 E "4-"0G / E 17. &utput3 '() E +627,2.-.2- +627,2...
Answer: c
Diff: $
Time line3 7 1 " . 0 2 Cears k E 17H U U U U U U U +11,777 -,"77 .,.77 -,177 ",.77 ",-77 -,777 '() E ? Fepreciation cash flows3 ?!CD Fepreciation 'ew !sset &ld !sset Change in Cear Dates Fepreciation Fepreciation Fepreciation 1 7."7 6 0,777 6 -,777 6 ",777 " 7.-" 8,777 -,777 0,777 7.19 .,407 -,777 1,407 . 7.1" -,777 -,777 7 0 7.11 ",407 -,777 *"07, 2 7.72 1,077 1,077 6"0,777 610,777 617,777 (ro#ect analysis worksheet3 / /nitial outlay 1, 'ew e=uipment cost *6"0,777.77, ", ?arket value old e=uip. 1-,---.--, Tax savings sale of old e=uip. 222.24Q ., /ncrease in 'WC ++ 0, Total net investment *611,777.77, Q*?arket value + 5ook value,*Tax rate, *61-,---.-- + 610,777,*7.., E 6222.24. // &perating cash flows Cear3 7 1 " . 0 2 2, 5efore+tax savings new e=uip. 6.,777 6.,777 6.,777 6.,777 6.,777 6.,777 4, !fter+tax savings new e=uip.*line 2 7.2, ",.77 ",.77 ",.77 ",.77 ",.77 ",.77 8, Feprec. new machine 0,777 8,777 .,407 -,777 ",407 1,077 9, Feprec. old machine -,777 -,777 -,777 -,777 -,777 7 17, Change in deprec. *line 8 + 9, ",777 0,777 1,407 7 *"07, 1,077 11, Tax savings from deprec. *line 17 7.., 877 ",777 477 7 *177, 277 1", 'et operating C%s *line 4 P 11, 6-,"77 6.,.77 6-,177 6",.77 6",-77 6-,777 /// Terminal year C%s 1-, 1stimated salvage value 7 1., Total terminal yr C% 7 /) 'et C%s 10, Total 'et C%s *611,777,6-,"77 6.,.77 6-,177 6",.77 6",-77 6-,777
++,(*
%inancial calculator solution3 /nputs3 C%7 E +11777G C%1 E -"77G C%" E ..77G C%- E -177G C%. E ".77G C%0 E "-77G C%2 E -777G / E 17. &utput3 '() E 6",2-0.-7 6",2-0. 91 Replacement project #RR Answer: c
Diff: $
Time line3 7 1 /DD E ? U U +14,277 -,.77 '() E ? Fepreciation cash flows3 ?!CD Fepreciation Cear Dates 1 7."7 " 7.-" 7.19 . 7.1" 0 7.11 2 7.72
" U .,8.7
U -,"87
. U ",..7
0 U -,2.7
'ew !sset Fepreciation 6 2,777 9,277 0,477 -,277 -,-77 1,877 6-7,777
&ld !sset Fepreciation 6 ",777 ",777 ",777 ",777 ",777 617,777
Change in Fepreciation 6 .,777 4,277 -,477 1,277 1,-77 1,877 6"7,777
(ro#ect analysis worksheet3 / /nitial outlay 1, 'ew asset cost *6-7,777, ", ale of old asset 1.,777 -, Tax on sale of old asset *1,277,Q ., /ncrease in 'WC ++ 0, Total net investment *614,277, Q* ale value + 5ook value,*Tax rate, E *1.,777 + 17,777,*7..7, E 61,277. // &perating cash flows
Cear3 7 1 " . 2, 5efore+tax savings new asset 6-,777 6-,777 6-,777 6-,777 4, !fter+tax savings new asset *line 2 7.2, 1,877 1,877 1,877 1,877 8, Feprec. new asset 2,777 9,277 0,477 -,277 9, Feprec. old asset ",777 ",777 ",777 ",777 17, Change in deprec. *line 8 + 9, .,777 4,277 -,477 1,277 11, Tax savings from deprec. *line 17 7.., 1,277 -,7.7 1,.87 2.7 1", 'et operating C%s *line 4 P 11, -,.77 .,8.7 -,"87 ",..7 /// Terminal year C%s 1-, 1stimated salvage value 1., Tax on salvage value *1,777 + 1,877,*7.., 10, Deturn of 'WC 12, Total termination C%s /) 'et C%s 14, Total 'et C%s *614,277, 6-,.77 6.,8.7 6-,"87 6",..7
6-,777 1,877 -,-77 ",777 1,-77 0"7 ",-"7 61,777 -"7 ++ 61,-"7 6-,2.7
%inancial calculator solution3 /nputs3 C%7 E +14277G C%1 E -.77G C%" E .8.7G C%- E -"87G C%. E "..7G C%0 E -2.7. &utput3 /DD E 7.7H.
9"++,(* Replacement project
Answer: d
Diff: $
%irst calculate C%73 The old e=uipment can be sold for 68,777, but the book value *5), of the old e=uipment is 617,777 + 61,877 E 68,"77. Thus, the company will reali@e a loss on the sale of 6"77. The loss reduces taxes by 6"77*7..7, E 687. C%7 includes the cost of the new e=uipment, net of the sale proceeds and the tax effect of the sale e=uipment, or
+610,777 P 68,777 P 687 E +62,9"7. econd, we must calculate the operating C%s. The operating C%s are comprised of the after+tax change in operating income and any tax effect of the change in depreciation expense from the old machine to the new. The new e=uipment will reduce costs by 61,777 per year and increase sales by 6",777 so before+ tax operating income will increase by 6-,777 per year. The after+tax increase in operating income for t E 1 + . is 6-,777*1 + 7.., E 61,877. The operating C%s are calculated as follows3
Time 1 " . Fep. 'ew 610,777*7.--, 610,777*7..0, 610,777*7.10, 610,777*7.74, Fep. &ld Fiff. Tax 1ffect 61,877 6-,107 6-,107*7.., E 61,"27 1,877 .,907 .,907*7.., E 1,987 1,877 .07 .07*7.., E 187 1,877 +407 +407*7.., E +-77 P /ncreased &p /nc. E C% 61,877 6-,727 1,877 -,487 1,877 1,987 1,877 1,077
E 6.,907 E 2,407 E ","07 E 1,707
++,(*
The old machine could have been sold for its 5) or 61,777 at t E .. This represents an opportunity cost of replacement. Thus, C%. E 61,077 + 61,777 E 6077. The relevant cash flows are then C%7 E +62,9"7, C%1 E 6-,727, C%" E 6-,487, C%- E 61,987, and C%. E 61,077. Fiscounting at 1" percent yields an '() of 600".2". 9New project N&' Answer: d Diff: $ tep 13 Calculate depreciation3 Fep 1 E 177,777*7.--, E --,777. Fep " E 177,777*7..0, E .0,777. Fep - E 177,777*7.10, E 10,777. Fep . E 177,777*7.74, E 4,777. Calculate cash flows3 C% 7 E +177,777 + 0,777 C% 1 E 07,777 P --,777 C% " E 27,777 P .0,777 C% - E 47,777 P 10,777 C% . E 27,777 P 4,777 P E +170,777. E 8-,777. E 170,777. E 80,777. 0,777 P 10,777 E 84,777.
tep "3
tep -3
Calculate '()3 >se C% key on calculator. 1nter cash flows shown above. 1nter /JCD E 1"H. olve for '() E 6128,27..

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(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Conceptual Easy:

Relevant cash flows

Relevant cash flows

Relevant cash flows

. Which of the following statements is most correct?

Answer: c a cash flow that results

Diff: E from the

Which of the following is not decision to accept a pro#ect?

Relevant cash flows

Relevant cash flows

Relevant and incremental cash flows

New project cash flows

Accepting risky projects

Risk and project selection

ensitivity! scenario! and simulation analyses

Relevant cash flows

Relevant cash flows

Relevant cash flows

Relevant cash flows

#ncremental cash flows

Cash flow estimation

Cash flow estimation

ensitivity! scenario! and simulation analyses

"onte Carlo simulation

Multiple Choice: P+o,lems Easy:

#nventory and N&'

N&' with e%ternalities

e. +6-,74","8-.00 Answer: c Diff: " N

After(ta% salvage value

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

New project N&'

?ills ?ining is considering an expansion pro#ect. has the following features3

The proposed pro#ect

New project #RR

e. '()! E 6 194G '()5 E 61,810 Risk(adjusted discount rate

Risk(adjusted discount rate

Discounting risky outflows

Discounting risky outflows

Discounting risky outflows

)ptimal project selection

Date of Deturn 1.H 17 111

d. +60,.17,0"e. +6 4.8,-48 New project N&'

'et /ncomeQ 607,777 27,777 47,777 27,777

?!CD Fepreciation Dates 7.-7..0 7.10 7.74

New project N&'

c. 6"7,02.."d. 6"",80-.97 e. 6"8.98".2.

New project N&'

New project #RR

N&' and risk(adjusted discount rate

What is the net investment re=uired at t E 7? a. b. c. d. +6.",777 +6.7,777 +6-8,277 +6-4,277

e. +6-2,277 )perating cash flow

".7 61,..7 61,777 "88, 1,777, *6 "88, VVVVVV 61,10"

6977 .07 077 6 07, "7, *6 -7, 077 6.47

6.47 6-97 6217 + + " 1.17 1.17, 1.17,