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

**Multiple Choice: Problems
**

(Note: MACRS accelerated depreciation rates should be given for many of these problems. These rates are provided in the text in Chapter 11, Table 11-2.)

Easy:

Investment outlay

1

Answer: c

Diff: E

.

The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000. The old machine, which originally cost $40,000, has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000. Target's corporate tax rate is 40 percent. If Target sells the old machine at market value, what is the initial after-tax outlay for the new printing machine? a. b. c. d. e. -$22,180 -$30,000 -$33,600 -$36,000 -$40,000 Answer: c Diff: E

**Risk-adjusted discount rate
**

2

.

Dandy Product's overall weighted average required rate of return is 10 percent. Its yogurt division is riskier than average, its fresh produce division has average risk, and its institutional foods division has below-average risk. Dandy adjusts for both divisional and project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is 4 percentage points. What is the risk-adjusted required rate of return for a low-risk project in the yogurt division? a. 6% b. 8% c. 10% d. 12% e. 14%

Chapter 11 - Page 1

000.093 -$58. e.394 -$14.000 annually. and it expects to sell the machine at the end of its 5-year operating life for $10.000 annually. and it uses a 12 percent cost of capital to evaluate projects of this nature.Medium: [MACRS table required] New project NPV 3 Answer: d Diff: M .512 -$21. Mars's marginal tax rate is 40 percent. what is the project’s NPV? a.493 -$46. -$15.040 Chapter 11 . If the machine's cost is $40. Stanton's marginal tax rate is 40 percent. If the machine costs $60.000. $1. c. d. and it expects to sell the machine at the end of its 5-year operating life for $10. but required working capital will return to the original level when the machine is sold after 5 years.014 $2. b. and it uses a 9 percent cost of capital to evaluate projects of this type.000 annually and increase earnings before depreciation and taxes by $6.901 [MACRS table required] New project NPV 4 Answer: b Diff: M .000.000 when the machine is installed. Stanton will use the MACRS method to depreciate the machine. d.292 $7. b. c. is considering the purchase of a new machine which will reduce manufacturing costs by $5.550 $ 817 $5. what is the project's NPV? a. The firm expects to be able to reduce net operating working capital by $15. is considering the purchase of a new machine which will reduce manufacturing costs by $5. e. Mars will use the MACRS accelerated method to depreciate the machine. Mars Inc.000 before taxes. Stanton Inc.Page 2 .

$2 million the third year (t = 3). c. inventory will increase by $140.62 -$ 838. The company’s tax rate is 40 percent. The machine will be depreciated on a straight-line basis over 4 years (that is. 3.97 -$1. the proposed project is riskier than the average project for Parker.997. The company is considering introducing a new detergent.000 and accounts payable will increase by $40. (Note: You may or may not need to use all of this information.89 -$ 778.58 -$ 824.000.New project NPV 5 Answer: c Diff: M . the project’s WACC is estimated to be 12 percent. a.Page 3 . The company’s interest expense each year will be $100.418. The company’s CFO has collected the following information about the proposed product.006. use only the information that is relevant.583.903.43 • • • • • • Chapter 11 . The company will have to purchase a new machine to produce the detergent. However. At t = 4. The new detergent is expected to reduce the after-tax cash flows of the company’s existing products by $250. The detergent is expected to generate sales revenue of $1 million the first year (t = 1).000.000 in each of the first four years (t = 1. What is the net present value of the proposed project? b.659. 2. the net operating working capital will be recovered after the project is completed. At the outset. Parker Products manufactures a variety of household products. its salvage value will equal zero. and 4). Each year the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue. t = 0. it will have an effect on the company’s net operating working capital. The machine has an up-front cost (t = 0) of $2 million. 2. and 4). and $1 million the final year (t = 4). The company’s overall WACC is 10 percent. the company’s depreciation expense will be $500. d. e. 3. $2 million the second year (t = 2). -$ 765. If the company goes ahead with the proposed product. and that after four years. The company anticipates that the machine will last for four years.) • • The project has an anticipated economic life of 4 years.000 a year (t = 1.

is considering the development of one of two mutually exclusive new computer models. a riskier-than-average project. of $15. of $7. Real Time adds 2 percentage points to arrive at a risk-adjusted cost of capital when evaluating a high-risk project. a supplier of computer safeguard systems.968. B with Both A B with A with A with a NPV and B a NPV a NPV a NPV of $10. = $380. will produce cash flows of $146.590.590. is considered a high-risk project. of less than average risk. Each will require a net investment of $5. Both have a cost of $200. of the statements above is correct..Page 4 . The cash flow figures for each project are shown below: Period 1 2 3 Project A $2. of $8.104. = $5. Answer: c Diff: M Risk-adjusted NPV 7 . NPVB = $1. uses a cost of capital of 12 percent to evaluate average-risk projects. Chapter 11 . e. while Model A is of average risk.042. b. Real Time Systems Inc.Risk-adjusted NPV 6 Answer: a Diff: M .001. because both have NPVs greater than zero. which will use a new type of laser disk drive. c.411 at the end of Years 3 and 4 only. Currently.600 2.815. will produce annual end of year cash flows of $71. NPVB = $1. Virus Stopper should accept a. Virus Stopper Inc. Project A.500 2. = $197.380.900 Model B. The cost of capital used for averagerisk projects is 12 percent. e. two mutually exclusive projects are under consideration. d. b.000 2. and it adds or subtracts 2 percentage points to evaluate projects of more or less risk. c.000 and will last 4 years. NPVA NPVA NPVA NPVA None = $380. NPVB = $1. Which of the following statements regarding the NPVs for Models A and B is most correct? a. d. Project B.250 Project B $3.590.177.000.000 2. NPVB = $6.

000 10. has asked you to evaluate the proposed acquisition of a new computer.848% Average Project D -$100. E C. The computer is expected to be used for 3 years and then be sold for $25. Purchase of the computer would require an increase in net operating working capital of $2. d.000 11. while projects of above-average risk have a cost of capital equal to 13 percent. B. E D D C. None of the projects will be repeated. and the project's cost of capital is 14 percent. New project investment 9 Answer: a Diff: E .000 16. Year (t) 0 1 2 3 4 IRR Project Risk Project A -$200. and it falls into the MACRS 3-year class. B.000 66. B. The computer would increase the firm's before-tax revenues by $20. b.000 50.000 40. Projects A and B are mutually exclusive.630% Above Average Which projects will the firm select for investment? a. c.000 30.Risky projects 8 Answer: d Diff: M . The following table summarizes the cash flows.000 40.000 30. The computer's price is $40. D.000 66.000 30.000 12.000.000 35. Projects: Projects: Projects: Projects: Projects: A.000 30. Cochran Corporation has a weighted average cost of capital of 11 percent for projects of average risk.000 per year.000 66. A.000 25. D Multiple part: (The following information applies to the next four problems.000 per year but would also increase operating costs by $5. The firm's marginal tax rate is 40 percent.038% Below Average Project C -$100.Page 5 .636% Above Average Project E -$100.000 30. C.000 30. What is the net investment required at t = 0? Chapter 11 . e.000.) [MACRS table required] The president of Real Time Inc. and risk of each of the projects.000 40.000 30.000 40.110% Below Average Project B -$100.000.000 30. internal rate of return (IRR). whereas all other projects are independent. Projects of below-average risk have a cost of capital of 9 percent.000 40.000 66.000 14. B. D.

803 $2. -$42. b. New project investment Answer: d Diff: E Chapter 11 .120 $19. and it will be sold after three years for $20. c.917 $5.000 per year in before-tax operating costs.) [MACRS table required] You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. Use of the truck will require an increase in net operating working capital (spare parts inventory) of $2. $2.000.Page 6 . $ 9. d.600 -$37.687 $13. c. The firm's marginal tax rate is 40 percent. e. d. c.712 $6.600 Answer: e Diff: M Operating cash flow 10 . The truck falls into the MACRS three-year class.000 -$38.000 $25.000.000 -$40. b. The truck's basic price is $50. e.240 $11. What is the total value of the terminal year non-operating cash flows at the end of Year 3? a.000 $10. d.a.000 $27. $18. b.200 Answer: a Diff: M Non-operating cash flows 11 .000 $21. What is the project's NPV? a. e.000 to modify it for special use by your firm. d. e.600 -$36. but it is expected to save the firm $20.000 Answer: c Diff: M New project NPV 12 .453 $16. c.438 (The following information applies to the next four problems. and it will cost another $10.000. mainly labor. The truck will have no effect on revenues.622 $2. b. What is the operating cash flow in Year 2? a.

d.Page 7 .600 -$55.737 Answer: c Diff: M Non-operating cash flows 15 .000 -$65. a.000 $12. $1. e. The truck's cost of capital is 10 percent. c.034 Chapter 11 . e. d.680 $16. b. What is the net investment in the truck? (That is. b. $ 562 e.000 -$52.000 $18.000 Answer: c Diff: M Operating cash flow 14 . -$50.121 $21. -$ 562 c.254 $19.800 -$62. $ 0 d. d.000 Answer: a What is its NPV? Diff: M New project NPV 16 .920 $20. What is the operating cash flow in Year 1? a. b.820 $18. $10.13 . What is the total terminal (non-operating) cash flow at the end of Year 3? a. -$1. e. what is the Year 0 net cash flow?) a. $17. c.547 b.000 $15. c.

CHAPTER 11 ANSWERS AND SOLUTIONS Chapter 11 .Page 8 .

880 ($ 1.560) IV Net CFs 13) Total Net CFs ($45.680 NPV = ? Depreciation cash flows: MACRS Year Percent 1 0. 3 .880 2. New project NPV Answer: d Diff: M Time line: 0 1 r = 12% 2 3 4 5 Years -45.000 19.200 6.800 $10.11 6 0.680 4. the required rate of return is 10 percent.$3.920) Numerical solution: .1.000) 12) Total termination CFs (7.200 6.200 11.000 60.920 Annual Depreciation $12.880 $ 5.000 $ 5.000 60. ($45.000 3.800 $10.000 $ 5.800 10.4) = After-tax outlay = -$60.000 + 24. for a low-risk project.000 10) Tax on salvage value ($10.32 3 0.2% = 10%.560 $ 5.400 -$33.000 60.000) II Operating cash flows 4) Reduction in cost $ 5.560 $ 5.000 6) Deprec.680 $ 7.000 3.4) (2. Therefore.600 3. rYD.640 III Terminal year CFs 9) Estimated salvage value $10.000 .600 7) Tax savings deprec. Dandy Product subtracts 2 percentage points.000 3.20 2 0.800 7.000 3) Total net inv.000(0. (line 6 × 0. in cost 3.000 Depreciable Basis $60.000 60. (from table) 12.06 7.000 5) After-tax dec.12 5 0.600)(0.Low-risk project = 10% + 2% .000) 2) Decrease in NWC 15.000 19.000 Project analysis worksheet: Year: 0 1 2 3 4 5 I Initial outlay 1) Machine cost ($60.400 7.000 $ 5. Investment outlay Initial outlay Cost of new machine Salvage value (old) Tax effect of sale = $6.000 $ 5.400 7.000 60. Risk-adjusted discount rate Answer: c Diff: E rYD = 10% + 2% = 12%.600 Answer: c Diff: E 2 . However.560 5.19 4 0.640 8) Net operating CFs (line 5 + 7) $ 7.000 7.000 + 2.000 3.680 $ 7.560 2.200 11.880 -1.560) 11) Return of NWC (15.000) $ 7.600 $60.4) 4.

800 4.$1.000 4.520 $15.000 5) After-tax increase in earnings (line 4 × 0. & tax $ 6.600 6) Before tax reduction in cost 5. Financial calculator solution: Inputs: CF0 = -45. Output: NPV = -$21.960 $11.000 7) After tax reduction in cost (line 6 × 0.640 8.125) = -$45.560.000.000 3.000 40. CF4 = 5.000 9) Deprec.493.000 40.12) + $10. tax savings (line 8 × 0.680.800 3.000 .6) 3.040) -6.000 + $7.680(0.000 $ 6.000 8) Deprec.123) + $5.600 5.800 7.600 5.120 3.640 $ 8.800 11.800 4 5 $ 6.000 3.000 40.720 = ? Depreciation cash flows: MACRS Year Percent 1 0.000 $ 6.400 5.000 2 3 Project analysis worksheet: Year: 0 1 I Initial outlay 1) Machine cost ($40. CF2 = 10.760 _______ _______ _______ _______ $11.7972) + $7.20 2 0.000 40.$1.600 5.4) 3.000 4.492.11 6 0.000 $ 6.000 3.800 3.000 7.$2.600 4.4) 13) Return of NWC 14) Total termination CFs IV Net CFs 15) Total Net CFs ($40.000) $ 9.7118) + $5.720 $ 9.122) + $7.600 5.000 NPV Depreciable Basis $40.000 (3.800(1/1.880.493.800 III Terminal year CFs 11) Estimated salvage value 12) Tax on salvage value ($10.000) II Operating cash flows 4) Inc.400)(0. CF1 = 7. (from table) 8.000 3.000 40.24 ≈ -$21.720 $ 9.920 1.680(1/1.74 ≈ -$21.000 3. I = 12.000 + $7.880(1/1.32 3 0. CF3 = 7.800(0.000) 2) Decrease in NWC -3) Total net inv.400 $40.NPV = -$45. 4 .19 4 0.000 12.000 9.320 .600 3.400 2. ($40.880(0. CF5 = -1.040 1.920.520 $ 8.000 12.640 $ 8.5674) = -$21.6355) .12 5 0. New project NPV Answer: b Diff: M Time line: 0 r = 9% 1 2 3 4 5 Years -40.800.8929) + $10.560(1/1.124) .320 Annual Depreciation $ 8.493.560(0.4) 3.200 10) Net operating CFs _______ (line 5 + 7 + 9) $ 9.360 $10.920(0.920(1/1.520 15.06 9. in earnings before deprec.

000$2.09) + $11.$200.093) + $8.177.7513) + $146.000Change in NWC -100Initial outlay2.8417) + $9.411(1/1.6830) . Financial calculator solution: Inputs: CF0 = -40.Nj = 2.43 ≈ $10.095) = -$40.292. Inc.000.001.411.CF2 = 146.175.291. CF1 = 71.720(1/1.7084) + $15.6499) = $2.104 [(1/0.104 71.411(0. Project B Low risk rRisk adjusted = 12% .14)-(1/(0.092) + $9. 6. select Project B. taxes$ 0 $ 500$ 500$ 0Taxes (40%) 0 200 200 0Oper. B Inputs: CF0 = -200.418.000.60 ≈ $7.Numerical solution: NPV = -$40.292.000 71.000 = $146.176.CF1 = 0.291. Greater precision in the PVIF factors produces identical answers.800(1/1. CF4 = 8. Inc.320(1/1.104 71.72.104 4 Years | 146.7722) + $8.000 + $9. Nj = 4. Since they are mutually exclusive.001. CF1 = 9.800(0. I = 9.411(0.520.000 1. Risk-adjusted NPV Time lines: Project A 0 r = 14% 1 2 3 | | | | CFsA -200.720(0.$200.62.9137) .520(0. Note: The difference in the NPVB between the numerical solution and financial calculator cash flow solution of $4. NPVB = $146.Nj = 2. from project$ 0$ 300$ 300$ 0Depr.144) .$200. New project NPV (In Thousands of Dollars) t = 0 t = 1 t = 2 t = 3 t = 4Initial cost-2.000 = $7.411 Tabular solution: NPVA = $71.094) + $15.104(2.640(1/1. Output: NPVA = $7. 500 500 500 500Change in other products250250250250Return of NWC________________________+ 100Net cash flow (NCF)-2.320(0. CF3 = 9.2% = 10%.29 ≈ $2. bef.000 + $9.000 0 0 146.$200.800. Financial calculator solution: A Inputs: CF0 = -200. I = 14.000Op.30. 7 .997.13 is due to rounding.104 NPVA = ? Project B 0 r = 10% 1 2 3 | | | | CFsB -200.320.411 NPVB = ? Calculate required returns on A and B: Project A High risk rRisk adjusted = 12% + 2% = 14%.640(0.720. 5.640.000 500Depr. 500 500 500 500Op.100Sales$1.100$ 250$ 550$ 550$ 350 Entering the NCF amounts into the cash flow register (at 12%) gives you a NPV of -$824. Output: NPV = $2.000.9174) + $11.104.90 ≈ $2.411(1/1.143) + $146.14 (1.000 = $71. Project B has the higher NPV.000$1.000$2. Output: NPVB = $10.I = 10.144)))] . CF2 = 11. CF5 = 15. Costs 500 1. Answer: a Diff: M Answer: c Diff: M 4 Years | 71.000 = $9.520(1/1.

500(0.250(1/1. CF1 = 2. Financial calculator solution: A: Inputs: CF0 = -5. CF2 = 2.$5.000 NPVB = ? Project A: Project B: Answer: c Diff: M 12% 1 | 2.900 rAverage risk = 12%.00% 13.250.000 = $3.8929) + $2.61 ≈ $1. Risky Projects Answer: d Diff: M 8 .250 14% 1 | 3. IRR.$5.$5.000(0.80 ≈ $1.000 = $2.822 $11. and hurdle rate for each project: Project A B C D E Hurdle 9.12) + $2.590. Risk-adjusted NPV Time lines: Project A 0 r = | CFsA -5. Numerical solution: NPVA = $2.600 3 Periods | 2. CF1 = 3.500. I% = 14.589.123) .00% 13.00% 9.000(1/1.000(1/14) + $2.998 . CF2 = 2. B: Inputs: CF0 = -5.35 ≈ $380. Look at the NPV.000.122) + $2.600(0.000 2 | 2.250(0.8772) + $2.500(1/1.00% 11.000(0.7695) + $2.20 ≈ $380. CF3 = 2.00% NPV $13.$5. Output: NPV = $1.900(1/143) .600.000 2 | 2.600(1/142) + $2.000. NPVB = $3.000 = $1.900. I% = 12.000 = $380.589.7118) .. CF3 = 2.000 NPVA = ? Project B 0 r = | CFsB -5. Output: NPV = $380.590.7972) + $2.6750) .500 3 Periods | 2. rHigh risk = 12% + 2% = 14%.000.900(0.000.

000) 10 .200 $16. just D.142) + $29.33 0.000 18.000) 15.143) 11.000 9.520 . Projects C.200 18.000. (line 6 × 0.07 Depreciable Basis $40. 12 .400 $11.000 40.85% 16.000) (2.000) 15.000 40.280 2 $20. the projects undertaken are A and D.120 29. Therefore.000 40.000 (5.200(1/1.000) ($42.$2.000 1 $20.64% 11.880. Year 1 2 3 4 Operating cash flows: MACRS Percent 0.280(1/1.000 3 $20. New project NPV Time line: 0 r = 14% -42.000 7.000 2.000 9.04% 10.000 (5.60) 5) Depreciation 6) Tax savings deprec. D.000 6. Operating cash flow Depreciation schedule: Depreciable basis = $40.45 0.40) = $8.520(1/1.120 *(Market value .280 16.880)* 2.000 6.400 Answer: a Diff: M Answer: e Diff: M Year 1) Increase in revenues 2) Increase in costs 3) Before-tax change in earnings 4) After-tax change in earnings (line 3 × 0.000 1 2 3 Years Answer: c Diff: M 14.Book value)(Tax rate) ($25.40) 7) Net operating CFs (line 4 + 6) 11.IRR 12.000 9.200 Annual Depreciation $13. in this case. New project investment Answer: a Diff: E Initial investment: Cost Change in NWC ($40.000 + $14.14) + $16. so we pick Project A because it has the largest NPV.000 $18.800 $40.800)(0.000 (8.000 .000 13.280 $14. and E are independent so we pick the ones whose IRR exceeds the cost of capital.200 Numerical solution: NPVr = 14% = -$42.63% 9. Non-operating cash flows Additional Year 3 cash flows: Salvage value Tax on Salvage value Recovery of NWC 3 $25.000 2.000 (5. Projects A and B are mutually exclusive.000) 15.200 5.15 0.11% 14.400 TV = 18.

280(0. (line 3 × 0.918. New project investment Initial investment: Cost ($50.000 9.000.000.800 Numerical solution: NPVr = 10% = -$62.7513) = -$1.15 0. CF3 = 29.10) + $22. Financial calculator solution: Inputs: CF0 = -42.920 2 | 22.4) 5) Net operating CFs Non-operating cash flows Additional Year 3 cash flows: 3 Salvage value $20. CF2 = 22.14.800(0.000 27.000 60.800 7.280 Financial calculator solution: Inputs: CF0 = -62.000) Operating cash flow Depreciation schedule: Depreciable basis = $60.280(0.000 + $19.920 Annual Depreciation $19.800 $22. CF1 = 14.600 $15.32.680 *(Market value .81 ≈ -$1.000 .000 Total terminal year CF $15.920(0.33 0. 16. Time line: 0 r = 10% 1 | | -62.546.40) = $6.920.000 12.600 TV = 15.000.000 4.7695) + $29.000 3.= -$42.280.000 Year 1 $20.280. New project NPV Answer: a Diff: M MACRS Percent 0.102) + $31.8264) + $31.103) = -$62.8772) + $16. 3 Years | 15.000 60. 15 .000 9.000 12. I = 10.280(1/1. CF2 = 16.800(1/1. CF3 = 31.680 31. CF1 = 19.920(1/.000 + $19.920 $19.917.200.916.000 + $14.9091) + $22.000 10.000) Modification (10. .45 0. Output: NPV = $2.548.000 19.85 ≈ $2.200 $60. Year 1 2 3 4 Operating cash flows: 1) Before-tax cost reduction 2) After-tax cost reduction (line 1 × 0. Note: Numerical solution differs from calculator solution due to rounding. 13.6750) = $2.200(0.000) Change in NWC (2.600 Answer: c Diff: M Answer: c Diff: M Answer: d Diff: E 14 .000 12.800.07 Depreciable Basis $60.547.520.000 Tax on salvage value (6.000 2 $20.320.200)(0.000 19.000 60.$4.800 3 $20.800 27. Output: NPV = -$1.000) Total net investment = ($62.Book value)(Tax rate) ($20.320)* Recovery of NWC 2.6) 3) Depreciation 4) Tax savings from deprec.520(0. I = 14.

- Chapter 11 Cash Flow Estimation and Risk Analysis
- {97C20C31-76D1-4A1A-9CD7-D996362D6A0A}
- IFM10 Ch 10 Test Bank
- Chapter 12 Other Topics in Capital Budgeting
- Stock Valn
- Chapter 18
- Chapter 13 Capital Structure and Leverage
- Chapter 10 the Basics of Capital Budgeting
- TB_Chapter09
- Chapter 12
- Chapter 15
- Chapter 13
- Chapter 14
- Chapter 10
- Chapter 01
- Chapter 07
- Chapters 16 and 17 509
- Chapter 11
- Chapter 12
- Test Bank Chapter12
- Chapter 07 2
- FM11 Ch 09 Test Bank
- Chapters 16 20
- Chapter 05 3
- Exam Stuff 1
- Chapter 21 25
- Chapter 05 2
- Chapter 03
- {644F331F-5665-4789-B141-4A5B60389B32}.tb14
- Chapter 08
- Test_Bank

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