Chapter 9—Cash Flow and Capital Budgeting

MULTIPLE CHOICE 1. Gamma Electronics is considering the purchase of testing equipment that will cost $500,000. The equipment has a 5-year lifetime with no salvage value. Assume the new machine will generate aftertax savings of $100,000 per year for the five years. If the firm has a 15% cost of capital, what is the equivalent annual cost of the equipment? a. $32,924 b. $42,746 c. $49,158 d. $37,863 ANS: C NPV = -500,000 + 100,000/1.15 + 100,000/1.152 + 100,000/1.153 + 100,000/1.154 + 100,000/1.155 = -164,784 Suppose the equivalent annual cost is x, then x/1.15 + x/1.152 + x/1.153 + x/1.154 + x/1.155 = -164,784 x = -49,158 DIF: M REF: 9.4 Special Problems in Capital Budgeting

2. Thompson Manufacturing must choose between two types of furnaces to install. Model A has a 6 year life, and an NPV of $5,000. Model B has a 5 year life, and an NPV of $4,200. The relevant discount rate is 12%. Which model should be chosen? What’s the annual cash flow from that model? a. Model B; $1,165 b. Model B; $840 c. Model A; $833 d. Model A; $1,216 ANS: D Suppose the annual annuity of model A is x, and that of model B is y. x/1.12 + x/1.122 + x/1.123 + x/1.124 + x/1.125 + x/1.126 = 5000 x = $1216 y/1.12 + y/1.122 + y/1.123 + y/1.124 + y/1.125 = 4200 y = $1165 DIF: M REF: 9.4 Special Problems in Capital Budgeting

3. A firm is evaluating two machines. Both machines meet the firm’s quality standard. Machine A costs $40,000 initially and $1,000 per year to maintain. Machine B costs $24,000 initially and $2,000 per year to maintain. Machine A has a 6 year useful life and machine B has a 3 year useful life. Both machines have zero salvage value. Assume the firm will continue to replace worn-out machines with similar machines, and the discount rate is 7%. Which machine should the firm purchase? a. Machine A b. Machine B c. The firm is indifferent to the two machines d. Can’t tell from the given information

ANS: A Cash outflows for two machines: Year 0 1 2 3 4 5 6 NPV: DIF: H Machine A 40,000 1,000 1,000 1,000 1,000 1,000 1,000 $44,767 Machine B 24,000 2,000 2,000 2,000 26,000 2,000 2,000 $51,843

REF: 9.4 Special Problems in Capital Budgeting

4. Capital budgeting must be placed on an incremental basis. This means that ______ must be ignored and _______ must be considered. a. sunk cost; opportunity cost b. sunk cost; financing cost c. cannibalization; opportunity cost d. opportunity cost; net working capital ANS: A DIF: E REF: 9.2 The Relevant Cash Flows

5. Roger is considering the expansion of his business into a property he purchased two years ago. Which of the following items should not be included in the analysis of this expansion? a. Roger can lease the property to another company for $12,000 per year. b. Costs of hiring additional staff c. The property was extensively renovated last year at a cost of $15,000. d. The expansion will result in a slight increase of inventory carried. ANS: C DIF: M REF: 9.2 The Relevant Cash Flows

6. You are given the following information. What is the initial cash outflow? Purchase and installation of new equipment Sale price of replaced equipment Book value of replaced equipment When the new equipment is installed: Inventory increase Accounts payable increase Tax rate a. b. c. d. $9,400 $9,000 $13,000 $10,600 $12,000 $ 4,000 $ 3,000 $ 2,000 $ 1,000 40%

ANS: A 12,000 - (4000 - 1000*.4) + (2000 - 1000) = $9,400 DIF: M REF: 9.2 The Relevant Cash Flows

741 c. accounts receivable increases. Now it is replacing the cars with newer vehicles. What is the present value of depreciation tax savings associated with this machine? (MARCS tax depreciation schedule of a 3-year class asset: 33.45%*3m = 533400 0.4/1. $15. Assume a discount rate of 10% and a 40% tax rate. 14.33% in year 1. $998. and sold these cars for a total of $ 25.41% in year 4) a.4*7. inventory increases.000 .12 + 0.000 c. and 7.1 Types of Cash Flows 8.81%*3m 7.4*44.100.741 d. $1.900 b.964 DIF: E REF: 9.(25. $16.994741 DIF: M REF: 9.59% of the old cars. $17.13 = 0. A machine costs $3 million and has zero salvage value. Assume a tax rate of 40%.4*33.000 c. The machine is depreciated straight-line over 3 years for tax purpose.090. $25. $1.41%)*. Assume a discount rate of 10% and a 40% tax rate.000.1 Types of Cash Flows 9. $1.964 d. accounts receivable falls.684 ANS: D Year 1 2 3 4 DIF: M Depreciation expense 33.500 ANS: C 25. or accounts payable falls c.200.200.1 + 0.41%*3m = 88920 Total: 363600 440826 133524 60734 998684 REF: 9.4 = 17.000 three years ago. $994.000 b.41%*3m Tax savings 0. 44. The machine qualifies under the 3-year MARCS category. or interest rate falls d.090.000 ANS: B PV = 0. or accounts payable increases b. operating expenses fall.900 d.33%*3m = 399960 0.4/1. What is the cash inflow from the sale of these vehicles? a.81%*3m = 177720 0.1 Types of Cash Flows 10.45% in year 2. cost of goods sold falls.000 b. or current assets increase ANS: A DIF: M REF: 9.81% in year 3. The company has depreciated 92. $994.7. A machine costs $3 million and has zero salvage value. The cash flows associated with an investment project are as follows: . What is the present value of depreciation tax savings associated with this machine? a. inventory falls.4/1.000 . $1.1 Types of Cash Flows 11. Net working capital decreases when a.33%*3m 44.4*14.000*7.45%*3m 14. $400. Alpha Car Rental purchased 5 cars for a total of $100.

000 + 100.000 + 9.886 c.3m/1.12 + (540. $385. cash flows would continue to grow at 4 percent per year.04/(.215 DIF: M REF: 9. Lost revenue from its frozen pizza sales since some customers will switch to purchase the new frozen pasta c. The tax rate is 40%. The equipment is expected to have a 5-year lifetime with no salvage value and will be depreciated on a straight-line basis.360. -$303. what is the project’s NPV? a.000)/1.3m/1.3m/1. Cost of increasing shelf space at grocery stores b.000 NPV = -7. Assume a discount rate of 10%.12 + 1.04) = 540. $232. Cost of advertising the new product d.260 ANS: C NPV = = -3m + 1.13 = 0. What is the NPV of this investment? a.000 $ 200.000 $ 100.10-.000 In year 4 and beyond. Georgia Food is exploring the possibility of bringing a new frozen pasta to the market.2 The Relevant Cash Flows 13.220 b.000/1. At the end of each of the next three years.1 million each year for the 5 years and have operating expenses (not including depreciation) amounting to 1/3 of revenues.000/1. Market research funds the company has spent on testing the viability of the new product ANS: D DIF: M REF: 9. $631.13 = $694.360.000.1 Types of Cash Flows NARRBEGIN: Exhibit 9-1 Exhibit 9-1 A project requires an initial investment in equipment and machinery of $10 million.734 b. Which of the following items are not relevant for the project’s analysis? a.1 + 200. the investment will generate cash inflows of $1. A certain investment will require an immediate cash outflow of $3 million.3 million. If the discount rate is 10%.742 c.908 d. Refer to Exhibit 9-1. What is the net cash flow in year 1? . $694.104 d. the present value of cash flows in year 4 and beyond is PV = 540.06 = 9.000*1.000/0.215 ANS: D As of year 3. $423.000 $ 540.000.232908m DIF: E REF: 9. $211. NARREND 14.1 + 1. The project is expected to generate revenues of $5.1 Types of Cash Flows 12.Cash Flows Initial Outflow Year 1 Year 2 Year 3 -$7. -$276.

18m.4m 0.84/1. c.84m 2m 2. and the cost of capital is 10%.15 = 3.82m d.77m. 39% e.89m b.73m. 24% ANS: B Cash flow from year 1 to year 5 is the same. What is the present value of cash inflows from year 1 to year 5? What percentage of this present value is attributed to the tax benefits accruing from depreciation? a. d.12 + 2. $10.77m.84m PV of cash flows (y1-y5) = 2.4m 0.84m 3. 95% d.13 + .1m 1.7m 2. 7.7m 2.84/1.14 + 2.13 + 2.77m PV of depreciation tax savings (y1-y5) = 0.84/1. b. -$6.04m ANS: A Revenue: Expense: Depreciation: Pretax income: Tax: NI: Depreciation: Net cash flow: DIF: M REF: 9.77 = 28% DIF: M REF: 9.15 = 10. $2. $10. Assume the tax rate is 40%.84/1. -$2. Assume the tax rate is 40%.84m 2m 2.8/1.40m 0.77m c.8/1.84m 2.0m 1. and the cost of capital is 10%.1m 1.12 + .56m 0.84m NAR: Exhibit 9-1 15.14 + . Refer to Exhibit 9-1.03m 3. Revenue: Expense: Depreciation: Pretax income: Tax: NI: Depreciation: Net cash flow: 5.03/10. $12.1 Types of Cash Flows 5.1 + . 3.8/1. 24% b.a. 28% c.89m.8/1. 2. What is the net present value of the project? a.8/1.1 Types of Cash Flows NAR: Exhibit 9-1 16.1 + 2. $0. Refer to Exhibit 9-1.0m 1.84/1.27m ANS: B .56m 0.

18 0.75 0.93 3 1.84/1.45 .13 + 1. Sales are projected to be $1.482 d.1 .45 .75 0.1 + .27 NPV = -3.27/1. $72.75 0.Cash flow from year 1 to year 5 is the same.4m 0. Assume the tax rate is 40% and the cost of capital is 10%.84/1.14 = 0.75 0.080199m = 80.93 2 1.84m 2m 2.45 .5 .14 + 2.2 The Relevant Cash Flows NAR: Exhibit 9-1 17.93/1.1 Types of Cash Flows 18.1m 1.7m 2..000 immediately.1 -3 -3. Which of the following items will lead to a rise in net working capital? A.0m 1.5 million per year for the next four years.93/1.1 + 2.84/1. Raw materials are purchased prior to the sale of finished goods B.290 b.3 0.199 c. The project requires an initial $3 million outlay for equipment and machinery.56m 0.1 + .4 .000 at the end of year 4.5 .3 0.93/1. $89.75 0.18 0. The equipment can be sold for $400.77m DIF: M REF: 9.24 (=.5 .75 0.5 .84m NPV = -10 + 2.18 0. The firm increases its cash balance .3 0.3 0.84/1. $189. Revenue: Expense: Depreciation: Pretax income: Tax: NI: Depreciation: Net cash flow: 5.12 + 2.93 0.12 + .93 .45 .75 0.93 0.15 = 0.4) 1.93 .1 -0.84/1. The equipment will be fully depreciated straight-line by the end of year 4.18 0.4*.93 4 1. What is the NPV of this investment? a.13 + 2. Johnson Chemicals also needs to add net working capital of $100. Cost of goods sold and operating expense (not including depreciation) are predicted to be 30% of sales.199 DIF: H REF: 9.75 0. $80. The net working capital will be recovered in full at the end of the fourth year.909 ANS: B Year Rev Expense Depreciation EBIT NI Depreciation Operating cash flow Change in NWC Net investment Sale of equipment Net cash flow 0 1 1. Johnson Chemicals is considering an investment project.

273 DIF: E REF: 9. a. The firm buys inventory on credit E. Fox Entertainment should treat this $120.000 $106. c. Fox Entertainment is evaluating the NPV of launching a new iPet product. sunk cost b.C. If the nominal discount rate is 10% and expected inflation is 3%. a.000 $ 72. fixed cost b. cannibalization cost ANS: B DIF: E REF: 9.000 as a _________ for the capital budgeting decision now confronting the firm.000 $ 20. $112.000 as an engineer.273 d.C.000 $ 36.B.000. b.000 $ 48. The firm makes a sale on credit D.000 $ 80.000 last year to test the market viability of iPet.B.033 = 109.000*1.000 3 $160.000 should be treated as a __________ if Paul runs an NPV analysis of his graduate degree. d.2 The Relevant Cash Flows NARRBEGIN: Exhibit 9-2 Exhibit 9-2 The following data are projected for a possible investment project: Revenues Cost of Goods Sold Depreciation EBIT NARREND 1 $120. A project will generate a real cash flow three years from now of $100.B.504 ANS: C 100. Paul earns $60.000 $ 54. This $60.000 $ 38.C A. and he is considering quitting his job and going to graduate school. $109. $106.C A. fixed cost d. opportunity cost c.000 $ 40. $122.000 2 $140.000 $ 42.000 4 $180.000 $ 60.090 c.1 Types of Cash Flows 20.1 Types of Cash Flows ANS: A 19.2 The Relevant Cash Flows 21.D DIF: M REF: 9. what is the nominal cash flow for year 3? a. A. cannibalization cost ANS: C DIF: E REF: 9. Short-term interest rates fall a. Fox paid a market research firm $120. sunk cost d.000 . opportunity cost c.D.000 $ 4.551 b.E A.

400 c.400 DIF: M REF: 9.000 = 80. Working capital is anticipated to be variable at 10% of revenues.000 Net cash flow = 82.2. Refer to Exhibit 9-2. $161.000+20.1 Types of Cash Flows NAR: Exhibit 9-2 .600 ANS: B Operating cash flow = 106. and will be recovered in full at the end of year 4.000 DIF: M REF: 9. What is the initial cash outlay? a.000 on equipment. the working capital investment must be made at the beginning of each period.000 + 100. $300.000. the working capital investment must be made at the beginning of each period. the working capital investment must be made at the beginning of each period.000.14.000 d. Working capital is anticipated to be variable at 10% of revenues.600 DIF: M REF: 9. Refer to Exhibit 9-2.000) = 100.000*0. $82.000+60.600 c.6 NI + 80.400 d. What is the net cash flow to the firm in year 1? a.1 Types of Cash Flows NAR: Exhibit 9-2 23. Refer to Exhibit 9-2.600 b. $400 b. What is the net cash flow to the firm in year 4? a. $220.000*0.000 . The project requires an initial investment of $300.000 Sale of equipment at book value = 300.000 = -2.000 ANS: B initial cash outlay = working capital $12.600 d.000 depreciation = 82. $312.000 depreciation = 83. The project requires an initial investment of $300. $80.000 = 201.22.000 Net cash flow = 83. $201.(80.000 + initial investment $300. $2.400 e.000+40.400 Change in working capital = 12. $68. The tax rate is 40%.600 Change in working capital = 18. and will be recaptured in full at the end of year 4. The project requires an initial investment of $300.600 + 18.000 c.400 . Equipment will be sold at its book value at the end of year 4. The tax rate is 40%. $101.6 NI + 20. Working capital is anticipated to be variable at 10% of revenues.1 Types of Cash Flows NAR: Exhibit 9-2 24.000 b. $232. The tax rate is 40%.400 ANS: D Operating cash flow = 4. $183. and will be recaptured in full at the end of year 4.000 .

000/1.800/1.154 + x/1.500 and is expected to last 2 years with operating costs of $400 per year.000 201.152 + x/1.14 = 26.000 82.000/1.000 80.000 -312. Which printer should Sam’s Insurance purchase? What is the equivalent annual cost of this machine? a. Sam’s Insurance must choose between two types of printers.200 40.12 + 81.789 c.600 20.194 b. and will be recovered in full at the end of year 4.155 d.768.400/1. Printer B.500 and is expected to last 3 years with operating costs of $380 per year.154 + 5. $1.768.904 . -$20.000.600/1.000 83.400 2 22.400 80. Printer A costs $3. Printer B costs $2.000/1.016.000.200/1.761.570 ANS: D Year Net income Depreciation Operating cash flow Change in NWC Initial investment Sale of equipment Net cash flow 0 1 2.600 -12. Both printers meet the firm’s quality standard.768.1 Types of Cash Flows NAR: Exhibit 9-2 26.400 -2. Working capital is anticipated to be variable at 10% of revenues.000 82. $2.407.800 3 43.225 b. Then x/1. -$41.200 4 63.800 -2.500.789 ANS: D Present value of the equipment = 3. The equipment requires maintenance of $5. $26.172 x = 825. The tax rate is 40%.000 + 5.4 Special Problems in Capital Budgeting 27.000 83.000 81.13 + 201.153 + x/1.625 c.000 + 80. Refer to Exhibit 9-2. $2.570 DIF: H REF: 9.516.077 d.000/1.172.000 on equipment.152 + 5.000 NPV = -312.600 18. $825.155 = 2. $3.200 -2.1 + 80.15 + x/1. $750. the working capital investment must be made at the beginning of each period. Assume a cost of capital of 15% and no taxes.000 100. Printer A. $3.155 .760. Equipment will be sold at its book value at the end of year 4.000/1. $2.172 Suppose the EAC is x. $718. The project requires an initial investment of $300.800 60. $899.000/1.000 80. $24. What is the present value of the cost of the equipment? What is the equivalent annual cost of the equipment? a.25. Printer B.789 DIF: M REF: 9. Assume a discount rate of 10%. $2.153 + 5.15 + 5. Future Semiconductor is considering the purchase of photolithography equipment that will cost $3 million.155 = 2. After five years it will be sold for $500.000 at the end of each of the next five years.731 c.000 -300.106.947 b. What is the net present value of the project if the firm’s discount rate is 10%? a.

736 DIF: M REF: 9. The old truck can be sold for $7. If it is sold in one year. Arizona Truck Company (ATC) is considering the replacement of an old truck. At that time it will have to invest $2 million to build new capacity.1 + 120.4 Special Problems in Capital Budgeting 29.1 + 380/1. Then x/1.787 ANS: D Present value of the cost of printer A = 3500 + 380/1.500.121 b. However.13 = 4445 x = 1.840 DIF: M REF: 9.000. $4. the firm will receive a net cash inflow of $120. What is the NPV if the firm accepts the subcontractor job? a.712 d.12 = $3.843 c.712 DIF: H REF: 9. the resale price will be $5. None of the above ANS: B Present value of the cost of keeping the old truck for one more year = 7800 .787 Suppose the EAC of printer B is y.d. $5.4 Special Problems in Capital Budgeting 28.12 = 3194 y = 1.000/1.194 Suppose the EAC of printer A is x.500 just before selling the truck to make it attractive to a buyer.12 + 380/1.422 ANS: C NPV = 120.12 + 2500/1.12 + x/1. $328. Printer A.12 = 5. $5.13 = $4.13 = 12. but ATC will spend $2.4 Special Problems in Capital Budgeting 30.12 . A firm that manufactures DVD players for automakers currently has excess capacity. Assume a cost of capital of 12%. $298. Suppose that the firm can accept additional work as a subcontractor for another company.000/1.121 The future value one year from now is 5121*1.000. By doing so. What is the total cost of keeping the old truck for one more year? Express the cash flow in terms of its future value one year from now.445 Present value of the cost of printer B = 2500 + 400/1.1 + y/1. $12.000 immediately and in each of the next two years. $5.1 + 400/1.736 c. the firm will have to begin expansion two years earlier than originally planned to bring new capacity on line.000/1. a. Then y/1.000 + 120.000/1. The firm expects that it will exhaust its excess capacity in three years.376 e. A project generates the following sequence of cash flows over two years: .2.12 = 5.1 + 2.5500/1.264 b. Assume a discount rate of 10%.800 d. $1.1 + x/1.800 now. -$18.

1323m b.5*0. d. $1.122 = 56. [(1.4m b. $1. The salvage value of the asset is expected to be $0.3579m ANS: C In year 4.. the marginal tax rate.02) = 102 NPV = -40 + 8/1.4 ]operating cash flow + 0.4523m c. the maximum tax rate. Kelley Group also needs to add net working capital of $0. $56.8m and $0.3323 m DIF: M REF: 9. $50.12 + (10+102)/1.1m immediately.1 Types of Cash Flows 33.2 The Relevant Cash Flows 31. b.00 10.Year 0 1 2 Cash Flow ($ in millions) -40.7 m d.4) sale of equipment = 1. the terminal value. the minimum tax rate. The cash revenues and expenses in year 1 are expected to be $1. d.02/(. What is the investment’s cash flow in year 4? a.4 DIF: H REF: 9.4) + 0. the average tax rate.1 Types of Cash Flows 32. ANS: A DIF: E REF: 9.8 * 1. The value of a project at a given future point in time is known as: a.3323m d. b.00 8.0.5m respectively.5 * 1. .00 Assume that cash flows after the second year grow at 2% annually in perpetuity.033 )*(1-0.033 .12 . c. Both revenues and expenses are expected to grow at 3 percent per year.8m c. and the discount rate is 12%. $47. What is the NPV of the project? a. $54.1change of working capital + 0. $1. The asset will be fully depreciated to zero using the straight line method over its economic life.3*(1-0. net working capital. opportunity cost.4m ANS: A The terminal value of the project at year 2 is: 10*1. c. The tax rate is 40%. $1. and this capital will be recovered in full at the end of the project’s life.3m at the end of the fourth year. sunk cost. Kelley Group is considering an investment of $2 million in an asset with an economic life of four years. The percentage of taxes owed on an incremental dollar of income is called: a.

CAMRS c. ANS: B DIF: E REF: 9. ANS: D DIF: E REF: 9. b. b. terminal capital.1 Types of Cash Flows 38. marginal capital. c. RCMAS d. c. A cash outlay that has already been committed whether a project is accepted or not is known as a: a. Cash Flows that occur if and only if a project is accepted are: a.2 The Relevant Cash Flows 37. an accrual basis. this is known as: a. d. ANS: C DIF: E REF: 9. terminal value. terminal value. sunk costs. The system in the U. c. incremental cash flow. working capital. c.1 Types of Cash Flows 36. sunk cost. a cash basis. d. SCRMA ANS: A DIF: E REF: 9. marginal costs. d. The difference between current assets and current liabilities is known as: a. c. incremental cash flows. ANS: A DIF: H REF: 9.S. current cash flows. b. Accountants measure inflows and outflows of business operations on: a. b. net cost. a profit basis. net working capital. d. d. Cash flows on an alternative investment that a firm decides not to make are a(n): a.1 Types of Cash Flows 34. sunk cost.1 Types of Cash Flows 35. which defines the allowable annual depreciation deductions for various classes of assets is known as: a. b. b.2 The Relevant Cash Flows 39. MACRS b. . incremental costs. opportunity cost.ANS: B DIF: E REF: 9. sunk costs. When a firm introduces a new product and some of the new product’s sales come at the expense of the firm’s existing products.1 Types of Cash Flows 40. opportunity cost. c. cannibalization. terminal costs. ANS: D DIF: E REF: 9.

ANS: B DIF: M REF: 9. an increase in fixed assets. accruals d. a cash inflow. 5 years.1 Types of Cash Flows 43. decrease c. ANS: A DIF: M REF: 9. decrease c.1 Types of Cash Flows 46. c. a cash outflow. average tax rate. capital investing. An increase in inventory will _________ net working capital.1 Types of Cash Flows 45. expenses ANS: A DIF: E REF: 9. have no affect on d. cannot be determined.1 Types of Cash Flows 44. An asset that falls into the 3-year MACRS asset class is fully depreciated over: a. profit c. a decrease in fixed assets. d. d. A decrease in accounts receivable will _________ net working capital. marginal tax rate.d. increase b. ANS: D DIF: E REF: 9. ANS: C DIF: E REF: 9. When a firm cannot invest in every positive NPV project because of limited funds.1 Types of Cash Flows 42. capital rationing. capital budgeting. ANS: B DIF: M REF: 9. . 2 years. a. cash b. 3 years. c. increase b. An increase in net working capital represents: a. Financial analysts focus on _______ when evaluating potential investments. this is known as: a.1 Types of Cash Flows 47. a. an expense basis. b. b. The relevant tax rate for capital budgeting purposes is the: a. have no affect on d. b. cannot be determined. minimum tax rate. c. ANS: C DIF: M REF: 9. a. 4 years. b.1 Types of Cash Flows 41. maximum tax rate. c. d.

$10.000. Sales are expected to be $225. The cost of shipping and installation is an additional $10.000.004 c. The cost of the manufacturing equipment is $125. $19. Refer to DSSS Corporation. $19. $135.008 $ 19.33%.994 ANS: A Depreciation Basis Year 1 2 3 4 $135. Cost of goods sold will be 60% of sales. respectively.d.41% 100.81%.000) $ (10. $60. The year 1. What is the depreciation expense in year 1? a.2 The Relevant Cash Flows 49.000. The asset will fall into the 3-year MACRS class. The project will require an increase in net working capital of $10.81% 7.000 per year. and 7. $10. DSSS plans on ending the project and selling the manufacturing equipment for $25. NARREND 48. capital financing.4 MACRS percentages are 33.00% $ 44.996 b.2 The Relevant Cash Flows 50.004 $135.000) $(145. Refer to DSSS Corporation. At the end of three years.008 d.000 NAR: DSSS Corporation DIF: M REF: 9.000 % 33.000 ANS: C Initial Investment Outlay Cost of Machine Net Working Capital $(135.000. ANS: C DIF: E REF: 9. $60.994 . What is the initial investment outlay for this project? a.994 $ 10. 14. Refer to DSSS Corporation.004 c. $44.4 Special Problems in Capital Budgeting NARRBEGIN: DSSS Corporation DSSS Corporation DSSS Corporation is considering a new project to manufacture widgets.008 d.000 b.000) NAR: DSSS Corporation DIF: M REF: 9. $145.996 $ 60.45%.996 b.33% 44. $10. 44.000 d. $155. $44. The marginal tax rate is 40% and DSSS Corporation’s appropriate discount rate is 15%.45% 14. What is the depreciation expense in year 2? a.000 c.41%.

004 c. $44.33% 44.ANS: C Depreciation Basis Year 1 2 3 4 $135.994 $ 10.004 $135.33% 44.41% 100. $19.008 d.004 c.994 $ 10.000 % 33.45% 14.00% $ 44.81% 7. $44. $10.008 $ 19.2 The Relevant Cash Flows 52.41% 100.996 b.008 $ 19.45% 14.000 NAR: DSSS Corporation DIF: M REF: 9.004 $135.33% 44.81% 7.2 The Relevant Cash Flows 51.000 NAR: DSSS Corporation REF: 9.996 b.00% $ 44.994 ANS: D Depreciation Basis Year 1 2 3 4 DIF: M $135.994 ANS: B Depreciation Basis Year 1 2 3 4 $135. What is the depreciation expense in year 3? a. $60.008 $ 19. $19.2 The Relevant Cash Flows .004 $135.81% 7. Refer to DSSS Corporation.996 $ 60. $10. What is the book value of the machine at the end of year 3? a. Refer to DSSS Corporation.996 $ 60.41% 100.994 $ 10.000 % 33.000 % 33.00% $ 44.45% 14.996 $ 60. $60.000 NAR: DSSS Corporation DIF: M REF: 9.008 d.

000 $135.008 $ 17.996 $ 33.000 $ 12.803 d.487 ANS: A .994 $ 54.000 $135.000 $ 12. $70.803 3 $225.804 $ 19. $10. $54.∆ Fixed Costs .197 $ 10.203 $ 34.797 b.798 c.798 2 $225.797 NAR: DSSS Corporation REF: 9.798 2 $225.∆ Depreciation = ∆ EBIT .803 3 $225.008 $ 70.797 b. Refer to DSSS Corporation.2 The Relevant Cash Flows 55.994 $ 54. $70.804 $ 19.803 $ 44.008 $ 70.∆ Depreciation = ∆ EBIT .487 ANS: C Operating Cash Flows Year ∆ Annual Sales .487 ANS: B Operating Cash Flows Year ∆ Annual Sales .202 $ 19.∆ Taxes (40%) = ∆ Earnings After-Tax + ∆ Depreciation = Operating Cash Flow DIF: M 1 $225.798 c.000 $ 60.008 $ 17. Refer to DSSS Corporation.000 $135.000 $ 12.000 $ 44.803 d.007 $ 23. $10. What is the operating cash flow for year 3? a. $64.197 $ 10.000 $ 44.996 $ 33.000 $135.007 $ 23. What is the operating cash flow for year 1? a.53.000 $ 19.∆ Fixed Costs .797 NAR: DSSS Corporation REF: 9.000 $ 12.798 c.005 $ 13. $54.796 $ 60.993 $ 7.2 The Relevant Cash Flows 54.996 $ 64. $64.994 $ 58.000 $ 12.000 $135.203 $ 34. What is the operating cash flow for year 2? a.202 $ 19.803 $ 44.005 $ 13.803 d.000 $135.000 $ 19. $54. Refer to DSSS Corporation.993 $ 7.797 b.796 $ 60.996 $ 64.∆ Taxes (40%) = ∆ Earnings After-Tax + ∆ Depreciation = Operating Cash Flow DIF: M 1 $225.994 $ 58.∆ Annual Costs .∆ Annual Costs .000 $ 60. $10.000 $ 12. $64. $70.

Refer to DSSS Corporation.803 $ 44.000 $ 12.993 $ 7.001 NAR: DSSS Corporation 57.796 $ 60.798 2 $225.999) $19.∆ Fixed Costs .999 c.BV) @ 40% DIF: H REF: 9.799 b.197 $ 10. $83.2 The Relevant Cash Flows 58. $14.732 b.000 $135.∆ Annual Costs .000 $135.001 = $83. What is the total cash flow generated in year 3? a.799 Terminal Cash Flow Sale of Machine Tax on (SV .∆ Depreciation = ∆ EBIT .000 $(5.983 . Refer to DSSS Corporation.2 The Relevant Cash Flows 56.999) $10.001 NAR: DSSS Corporation DIF: H REF: 9.804 $ 19.000 $ 12.000 $ 19. $7.996 $ 64.000 $ 44.994 $ 58.214 d.098 ANS: A Operating Cash Flow + Terminal Cash Flow = $54.Operating Cash Flows Year ∆ Annual Sales . $19.008 $ 70.986 c. -$19.983 d.797 + $29.797 c.005 $ 13.994 $ 54. What is the NPV of the project? a.000 $29.BV) @ 40% Net Working Capital $25.797 NAR: DSSS Corporation REF: 9.008 $ 17. $5.001 ANS: D Sale of Machine Tax on (SV .000 $135.803 3 $225.203 $ 34.∆ Taxes (40%) = ∆ Earnings After-Tax + ∆ Depreciation = Operating Cash Flow DIF: M 1 $225. $54. $15.000 $(5.2 The Relevant Cash Flows $25. $25.000 $ 12.000 b.007 $ 23. What is the after-tax cash flow from selling the machine at the end of year 3? a.001 d.996 $ 33. $12. Refer to DSSS Corporation. $29.202 $ 19.000 $ 60. $19.

79% b. The cost of the manufacturing equipment is $150.2 The Relevant Cash Flows NAR: DSSS Corporation Year 1 $64. $135.798 $64.001 $83.36% ANS: A Projected Total Cash Flows Initial Investment Outlay Operating Cash Flow Terminal Cash Flow Total Project Cash Flow IRR DIF: H 0 $(145.799 NARRBEGIN: FAR Corporation FAR Corporation FAR Corporation is considering a new project to manufacture widgets.982. Cost of goods sold will be 80% of sales. The asset will fall into the 3-year MACRS class.000 ANS: D Initial Investment Outlay . The year 1-4 MACRS percentages are 33.000 c. 22.000.000.47% d. Refer to FAR Corporation.000) $(145. What is the IRR of the project? a.000) $(145. 14.000.000) 15% $19.803 $70. and 7.41%.797 $29.000 per year. 19.001 $83. The project will require an increase in net working capital of $15.000 d. What is the initial investment outlay for this project? a.798 $64.000 b.803 3 $54.803 3 $54.79% REF: 9.ANS: C Projected Total Cash Flows Initial Investment Outlay Operating Cash Flow Terminal Cash Flow Total Project Cash Flow Rate NPV DIF: H 0 $(145. -10. NARREND 60. The marginal tax rate is 40% and FAR Corporation’s appropriate discount rate is 12%. At the end of three years.81%. The cost of shipping and installation is an additional $15. $165.000.798 2 $70.799 59.798 2 $70. FAR plans on ending the project and selling the manufacturing equipment for $35. 44. respectively.45%.803 $70.33%. $145.2 The Relevant Cash Flows NAR: DSSS Corporation Year 1 $64. 27. $10. Refer to DSSS Corporation.01% c.000) 22.57 REF: 9.797 $29. Sales are expected to be $300.

215 c.000 % 33.000 NAR: FAR Corporation DIF: M REF: 9. $66. $66.33% 44.000) $(165.995 b. $49.115 d. What is the depreciation expense in year 2? a. What is the depreciation expense in year 3? a. Refer to FAR Corporation.81% 7.115 d. $22.00% $ 49.000 NAR: FAR Corporation DIF: M REF: 9. Refer to FAR Corporation.000) $ (15.2 The Relevant Cash Flows 62.000) REF: 9.33% 44. $22.675 ANS: A Depreciation Basis Year 1 2 3 4 $150.2 The Relevant Cash Flows 63.115 $150.115 d. $11.995 $ 66.81% 7. $49.000 % 33.675 $ 22. $11.675 ANS: B . $66.00% $ 49.995 b.45% 14.675 ANS: D Depreciation Basis Year 1 2 3 4 $150.995 b.215 c.215 c.675 $ 22.41% 100. $11.Cost of Machine Net Working Capital $(150.41% 100. What is the depreciation expense in year 1? a. Refer to FAR Corporation.115 $150.215 $ 11. $49.995 $ 66.2 The Relevant Cash Flows NAR: FAR Corporation DIF: M 61.45% 14. $22.215 $ 11.

41% 100.470 $55. -$52.000 % 33.Depreciation Basis Year 1 2 3 4 $150.995 $ 66.000) 12% $(21.597.2 The Relevant Cash Flows 65.41% 100.446 $78.215 $ 11. $21.115 d. Refer to FAR Corporation. $11.00% $ 49.215 c.115 $150. $44. What is the operating cash flow for year 1? a.215 $ 11. Refer to FAR Corporation.00% $ 49. What is the NPV of the project? a. -$21. Refer to FAR Corporation.675 $ 22.33% 44.489 ANS: C Projected Total Cash Flows Initial Investment Outlay Operating Cash Flow Terminal Cash Flow Total Project Cash Flow Rate NPV DIF: H 0 $(165.470 3 $37.000) $(165.798 2 $55.000 % 33.000 NAR: FAR Corporation DIF: M REF: 9. $55.45% 14.597 b.675 ANS: C Depreciation Basis Year 1 2 3 4 $150.995 $ 66.597 d.81% 7.000 NAR: FAR Corporation DIF: M REF: 9.1 Types of Cash Flows NAR: FAR Corporation 66.33% 44. $22.686 $40.2 The Relevant Cash Flows 64. What is the book value of the machine at the end of year 3? a.132 REF: 9.675 $ 22. $73.20) Year 1 $48.45% 14. $66.115 $150.995 b.470 .548 c.798 $48.81% 7.

What is the operating cash flow for year 3? a.000 c.000 c. Refer to FAR Corporation.000 $240. $48.470 3 $300. $60.314 $ 15.000 c.∆ Taxes (40%) = ∆ Earnings After-Tax + ∆ Depreciation = Operating Cash Flow DIF: M 1 $300. Refer to FAR Corporation.686 ANS: C Operating Cash Flows Year ∆ Annual Sales .2 The Relevant Cash Flows 68.000 $240. $48.675 $(18.000 $ 66.314 $ 15.686 ANS: A Operating Cash Flows Year ∆ Annual Sales .b.995 $ (1.000 $240.471 $ 22.000 $ 22.000 $ 66. $37.000 $240.798 d.215 $ 25.470 b.∆ Fixed Costs .∆ Annual Costs .000 $240.000 $ 12.000 $ 49.∆ Depreciation = ∆ EBIT .000 $ 12. $37.995 $ 48.995 $ (1.000 $ 12.∆ Taxes (40%) = ∆ Earnings After-Tax + ∆ Depreciation = Operating Cash Flow DIF: M 1 $300.000 $ 12.675 $(18.995) $ (798) $ (1.785 $ 10.470 b.2 The Relevant Cash Flows 67.215 $ 37.675) $ (7. $60.215 $ 37.205) $ 66.215 $ 25.205) $ 66.∆ Depreciation = ∆ EBIT .000 $ 12.798 d.686 NAR: FAR Corporation REF: 9.798 2 $300.000 $ 22. $55.675 $ 55.798 2 $300. $37.∆ Fixed Costs .798 d.471 $ 22. $55.∆ Annual Costs . What is the operating cash flow for year 2? a.197) $ 49.470 3 $300.686 ANS: D Operating Cash Flows . $48.000 $ 49.995) $ (798) $ (1.470) $(11.995 $ 48.675 $ 55.675) $ (7.686 NAR: FAR Corporation REF: 9.000 $ 12.470) $(11.000 $240. $60.197) $ 49.785 $ 10.

000 $240.92% d. 8.000 $ 22.446 ANS: D Terminal Cash Flow Sale of Machine Tax on (SV .∆ Annual Costs . Refer to FAR Corporation. $35.446 NAR: FAR Corporation DIF: H REF: 9.000 $ 12.995 $ 48.2 The Relevant Cash Flows 69. 5. $9.01% b.554 b.∆ Taxes (40%) = ∆ Earnings After-Tax + ∆ Depreciation = Operating Cash Flow DIF: M 1 $300.446 NAR: FAR Corporation 70.Year ∆ Annual Sales .554) $25. $9.675 $ 55.470 3 $300. $40.470) $(11. Refer to FAR Corporation.995 $ (1.675) $ (7. -$9.000 $40. $15.∆ Depreciation = ∆ EBIT .BV) @ 40% DIF: H REF: 9. 12.554 d.000 $240.74% c. Refer to FAR Corporation. $35.BV) @ 40% Net Working Capital $35.554 c. $25.78% ANS: D Projected Total Cash Flows Year .000 c.205) $ 66.471 $ 22.686 NAR: FAR Corporation REF: 9.000 $ 49.2 The Relevant Cash Flows 71.000 $ 66.000 $(9.995) $ (798) $ (1.000 d.000 $240.000 $ 12. What is the IRR of the project? a.314 $ 15.446 ANS: D Terminal Cash Flow Sale of Machine Tax on (SV .785 $ 10.215 $ 25.000 $ 12. What is the after-tax cash flow from selling the machine at the end of year 3? a. 4.2 The Relevant Cash Flows $35.∆ Fixed Costs .554) $15.000 $(9.000 b. What is the total cash flow generated in year 3? a.197) $ 49.675 $(18.798 2 $300.215 $ 37.

less ANS: B DIF: H REF: 9. human element. are equal to the firm’s opportunity costs. d. b.000) 4. managers often use the: a. should be considered when determining an investment’s relevant cash flows. ANS: A DIF: M REF: 9. more c. b. human analysis. ANS: B DIF: E REF: 9. human analysis.2 The Relevant Cash Flows 74. less b. all of the above.798 REF: 9. more d. Sunk costs: a. b. internal rate of return. payback method.Initial Investment Outlay Operating Cash Flow Terminal Cash Flow Total Project Cash Flow IRR DIF: H 0 $(165. Opportunity costs: a. c.132 $(165. ANS: A DIF: E REF: 9. all of the above.446 $78.78% $48.4 Special Problems in Capital Budgeting 75. are equal to the firm’s sunk costs. a. d. are irrelevant. are irrelevant.686 $40.798 2 $55.2 The Relevant Cash Flows 73. profitability index.5 The Human Face of Capital Budgeting . accounting rate of return. c.2 The Relevant Cash Flows NAR: FAR Corporation 72. To help rank projects in a capital rationing environment. c.470 3 $37. human element.000) 1 $48.470 $55. d. should be considered when determining an investment’s relevant cash flows. The _________ makes capital budgeting ________ complicated.