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LO8: (Appendix 8C) Income tax
Professional Exam Adapted

Difficulty
Question
Type ID Origin CMA/CPA origin
1 T/F M x 4/e: 15-900 Authors
4 T/F E x 2/15/98,C E.N.
Conceptual David
5 M/C M x ATB 8/e: 15-16 Keyes
Conceptual CMA, 12/93, Part4, CMA, 12/93, Part4,
6 M/C E x CMA Q20 CMA Q20
Conceptual
7 M/C M x New 1/3/2002,A E.N.
8 M/C E x 5/e: 15-34 Authors
9 M/C M x 2/15/98,A8 E.N.
10 M/C H x 4/e: 15-934 Authors
David
12 M/C M x CMA CMA,6/92,IV-12 CMA CMA, 6/92, IV-12
13 M/C M x 2/15/98,D8 E.N.
David
15 M/C M x 2/15/98,B8 E.N.
Larry
16 M/C E x 9eLD:CH15,Q14 Deppe
8C-1
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned,
duplicated, forwarded, distributed, or posted on a website, in whole or part.
19 M/C M x 2/15/98,C8 E.N.
Multipart 10/13/2003 Multi MC
8C-1 20-24 M/C M x C4 E.N.
8C-2 25-26 M/C M x E4 E.N.
8C-3 27-28 M/C M x F4 E.N.
Multipart 10/13/2003 Multi D
8C-4 29-32 M/C M x MC3 E.N.
10/14/2003 Problem
33 Problem M x K4 E.N.
34 Problem M x 7/10/2001,H7 E.N.
35 Problem M x 7/10/2001,G7 E.N.
10/14/2003 Problem
36 Problem M x J4 E.N.
8C-2
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned,
duplicated, forwarded, distributed, or posted on a website, in whole or part.
Appendix 8C
Income Taxes in Capital Budgeting Decisions
True / False Questions
1. The reduction in taxes made possible by the annual depreciation deductions equals the
depreciation deduction multiplied by the tax rate.
True False
2. The release of working capital at the end of an investment project is a taxable cash inflow.
True False
3. Not all cash inflows are taxable.
True False
4. When a company invests in equipment, it gets to immediately expense the cost of the equipment
on the company's tax reports.
True False
Multiple Choice Questions
5. In an equipment selection capital budgeting decision, which of the following will increase the
present value of the tax savings from the annual depreciation deductions?
A. an increase in the cost of capital.

B. an increase in the tax rate.
C. an increase in the salvage value of the equipment.
D. a decrease in the cost of new equipment.
8C-3
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
6. Depreciation expense reduces income taxes by an amount equal to:
A. one minus the tax rate times the amount of deprecation.

B. the tax rate times the amount of depreciation.
C. the amount of the depreciation.
D. one minus the amount of depreciation.
7. The after-tax cost of a deductible cash expense is:
A. The amount of the cash expense.

B. The amount of the cash expense times the tax rate.
C. The amount of the cash expense times 1 minus the tax rate.
D. Zero.
8. Last year the sales at Jersey Company were $200,000 and were all cash sales. The expenses at
Jersey were $125,000 and were all cash expenses. The tax rate was 30%. The after-tax net cash
inflow at Jersey last year from these operations was:
A. $37,500
B. $60,000
C. $22,500
D. $52,500
9. A company anticipates a taxable cash receipt of $30,000 in year 2 of a project. The company's tax
rate is 30% and its discount rate is 10%. The present value of this future cash flow is closest to:
A. $17,355
B. $7,438
C. $9,000
D. $21,000
10. Consider a machine which costs $115,000 now and which has a useful life of seven years. This
machine will require a major overhaul at the end of the fourth year which will cost "X" dollars. If the
tax rate is 40%, and if the after-tax cash outflow for this overhaul is $3,600, then the amount of "X"
in dollars is:
A. $6,000
B. $9,000
C. $2,160
D. $1,440
8C-4
11. Ring Corporation uses a discount rate of 12% and has a tax rate of 30%. The following cash flows
occur in the third year of an equipment selection investment project:
The total after-tax present value of the cash flows is closest to:
A. $10,152
B. $34,603
C. $60,235
D. $79,459
12. Superstrut is considering replacing an old press that cost $80,000 six years ago with a new one
that would cost $245,000. The old press has a net book value of $15,000 and could be sold for
$5,000. The increased production of the new press would require an investment in additional
working capital of $6,000. The company's tax rate is 40%. Superstrut's net investment now in the
project would be:
A. $256,000
B. $242,000
C. $250,000
D. $245,000
13. A company needs an increase in working capital of $10,000 in a project that will last 4 years. The
company's tax rate is 30% and its discount rate is 8%. The present value of the release of the
working capital at the end of the project is closest to:
A. $7,350
B. $3,000
C. $7,000
D. $5,145
8C-5
14. The Dill and Gherkin Law Firm is contemplating the decision to open up a branch office across
town. The firm would sign a 5-year lease for a fully furnished office for $24,000 per year. The
lease also requires a $30,000 security deposit upon signing. This deposit will be given back at the
end of the 5-year lease term. No other amounts will need to be invested. However, additional
operating costs are expected to be $65,000 per year for the 5 years. The firm expects to generate
an additional $100,000 of revenue per year for the 5 years from the branch office. The firm's after-
tax cost of capital is 16% and its tax rate is 30%. The net present value of this investment project
is closest to:
A. $(509)
B. $5,206
C. $9,490
D. $14,206
15. A company anticipates a taxable cash expense of $80,000 in year 2 of a project. The company's
tax rate is 30% and its discount rate is 10%. The present value of this future cash flow is closest
to:
A. $(56,000)
B. $(19,835)
C. $(46,281)
D. $(24,000)
16. Last year the sales at Seidelman Company were $700,000 and were all cash sales. The
company's expenses were $450,000 and were all cash expenses. The tax rate was 35%. The
after-tax net cash inflow at Seidelman last year was:
A. $700,000
B. $250,000
C. $162,500
D. $87,500
17. Last year the sales at Summit Company were $400,000 and were all cash sales. The expenses at
Summit were $250,000 and were all cash expenses. The tax rate was 40%. The after-tax net cash
inflow at Summit last year was:
A. $150,000
B. $60,000
C. $90,000
D. $400,000
8C-6
18. Suppose a machine costs $20,000 now, has an expected life of eight years, and will require a
$7,000 overhaul at the end of the third year. If the tax rate is 40%, then the after-tax cost of this
overhaul would be:
A. $12,000
B. $4,200
C. $8,000
D. $2,800
19. A company anticipates a depreciation deduction of $20,000 in year 3 of a project. The company's
tax rate is 30% and its discount rate is 14%. The present value of the annual depreciation
deductions resulting from this deduction is closest to:
A. $9,450
B. $14,000
C. $6,000
D. $4,050
Burry Inc. has provided the following data to be used in evaluating a proposed investment project:
For tax purposes, the entire initial investment without any reduction for salvage value will be
depreciated over 5 years. The company uses a discount rate of 11%.
20. When computing the net present value of the project, what are the annual after-tax cash receipts?
A. $338,000
B. $168,900
C. $394,100
D. $67,500
8C-7
21. When computing the net present value of the project, what are the annual after-tax cash
expenses?
A. $235,000
B. $217,000
C. $93,000
D. $403,000
22. By how much does the depreciation deduction reduce taxes each year in which the depreciation
deduction is taken?
A. $45,000
B. $75,000
C. $105,000
D. $32,143
23. When computing the net present value of the project, what is the after-tax cash flow from the
salvage value in the final year?
A. $22,500
B. $75,000
C. $52,500
D. $0
24. The net present value of the project is closest to:
A. $250,815
B. $84,495
C. $109,800
D. $276,120
Jenny Inc. has provided the following data concerning an investment project that has been
proposed:
The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated
over 5 years without any reduction for salvage value. The company uses a discount rate of 14%.
8C-8
A. $0
B. $31,500
C. $45,000
D. $13,500
A. $227,071
B. $58,113
C. $241,435
D. $43,749
Michelotti Inc. is considering an investment project that would require an initial investment of
$140,000 and that would last for 7 years. The annual cash receipts from the project would be
$105,000 and the annual cash expenses would be $47,000. The equipment used in the project
could be sold at the end of the project for a salvage value of $7,000. The company's tax rate is
30%. For tax purposes, the entire initial investment will be depreciated over 5 years without any
reduction for salvage value. The company uses a discount rate of 19%.
A. $73,500
B. $77,000
C. $58,000
D. $31,500
A. $11,914
B. $37,601
C. $10,464
D. $34,151
8C-9
Morgado Inc. has provided the following data to be used in evaluating a proposed investment
project:
The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated
over 5 years without any reduction for salvage value. The company uses a discount rate of 19%.
A. $39,000
B. $13,650
C. $54,600
D. $23,400
expenses?
A. $12,900
B. $30,100
C. $55,900
D. $30,000
31. By how much does the depreciation deduction reduce taxes each year in which the depreciation
deduction is taken?
A. $6,500
B. $15,167
C. $18,200
D. $7,800
A. $9,100
B. $3,900
C. $13,000
D. $0
8C-10
Essay Questions
33. Sarafin Inc. is considering a project that would require an initial investment of $693,000 and would
have a useful life of 7 years. The annual cash receipts would be $416,000 and the annual cash
expenses would be $208,000. The salvage value of the assets used in the project would be
$35,000. The company's tax rate is 30%. For tax purposes, the entire initial investment without
any reduction for salvage value will be depreciated over 5 years. The company uses a discount
rate of 15%.
Required:
Compute the net present value of the project.
34. Management is considering purchasing an asset for $30,000 that would have a useful life of 5
years and no salvage value. For tax purposes, the entire original cost of the asset would be
depreciated over 5 years using the straight-line method. The asset would generate annual net
cash inflows of $21,000 throughout its useful life. The project would require additional working
capital of $4,000, which would be released at the end of the project. The company's tax rate is
40% and its discount rate is 8%.
Required:
What is the net present value of the asset?
8C-11
35. A company is considering purchasing an asset for $50,000 that would have a useful life of 8 years
and would have a salvage value of $5,000. For tax purposes, the entire original cost of the asset
would be depreciated over 8 years using the straight-line method and the salvage value would be
ignored. The asset would generate annual net cash inflows of $26,000 throughout its useful life.
The project would require additional working capital of $8,000, which would be released at the end
of the project. The company's tax rate is 40% and its discount rate is 13%.
Required:
36. Eisenbeis Inc. has provided the following data concerning a proposed investment project:
The company's tax rate is 30%. For tax purposes, the entire initial investment without any
reduction for salvage value will be depreciated over 7 years. The company uses a discount rate of
13%.
Required:
8C-12
8C-13
Appendix 8C Income Taxes in Capital Budgeting Decisions Answer Key
True / False Questions
1. The reduction in taxes made possible by the annual depreciation deductions equals the
depreciation deduction multiplied by the tax rate.
TRUE
AACSB: Reflective Thinking

AICPA BB: Critical Thinking
AICPA FN: Measurement
Blooms: Understand
Learning Objective: 08-08 (Appendix 8C) Include income taxes in a capital budgeting analysis.
Level: 2 Medium
2. The release of working capital at the end of an investment project is a taxable cash inflow.
FALSE

Blooms: Understand
Level: 2 Medium
3. Not all cash inflows are taxable.
TRUE

Blooms: Understand
Level: 2 Medium
4. When a company invests in equipment, it gets to immediately expense the cost of the
equipment on the company's tax reports.
FALSE

Blooms: Remember
Level: 1 Easy
8C-14
Multiple Choice Questions
5. In an equipment selection capital budgeting decision, which of the following will increase the
present value of the tax savings from the annual depreciation deductions?
A. an increase in the cost of capital.

B. an increase in the tax rate.
C. an increase in the salvage value of the equipment.
D. a decrease in the cost of new equipment.

Blooms: Understand
Level: 2 Medium
6. Depreciation expense reduces income taxes by an amount equal to:
A. one minus the tax rate times the amount of deprecation.

B. the tax rate times the amount of depreciation.
C. the amount of the depreciation.
D. one minus the amount of depreciation.

Blooms: Remember
Level: 1 Easy
Source: CMA, adapted
7. The after-tax cost of a deductible cash expense is:
A. The amount of the cash expense.

B. The amount of the cash expense times the tax rate.
C. The amount of the cash expense times 1 minus the tax rate.
D. Zero.

Blooms: Understand
8C-15
Level: 2 Medium
8. Last year the sales at Jersey Company were $200,000 and were all cash sales. The expenses
at Jersey were $125,000 and were all cash expenses. The tax rate was 30%. The after-tax net
cash inflow at Jersey last year from these operations was:
A. $37,500
B. $60,000
C. $22,500
D. $52,500
AACSB: Analytic
Blooms: Apply
Level: 1 Easy
9. A company anticipates a taxable cash receipt of $30,000 in year 2 of a project. The company's
tax rate is 30% and its discount rate is 10%. The present value of this future cash flow is
closest to:
A. $17,355
B. $7,438
C. $9,000
D. $21,000
The answer without rounding error is $17,355.
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-16
10. Consider a machine which costs $115,000 now and which has a useful life of seven years. This
machine will require a major overhaul at the end of the fourth year which will cost "X" dollars. If
the tax rate is 40%, and if the after-tax cash outflow for this overhaul is $3,600, then the
amount of "X" in dollars is:
A. $6,000
B. $9,000
C. $2,160
D. $1,440
After-tax cost = (1 - Tax rate) × Tax-deductible cash expense

$3,600 = (1 - 0.40) × Tax-deductible cash expense
Tax deductible cash expense = $3,600 ÷ 0.60 = $6,000
AACSB: Analytic
Blooms: Apply
Level: 3 Hard
11. Ring Corporation uses a discount rate of 12% and has a tax rate of 30%. The following cash
flows occur in the third year of an equipment selection investment project:
The total after-tax present value of the cash flows is closest to:
A. $10,152
B. $34,603
C. $60,235
D. $79,459
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-17
12. Superstrut is considering replacing an old press that cost $80,000 six years ago with a new one
that would cost $245,000. The old press has a net book value of $15,000 and could be sold for
$5,000. The increased production of the new press would require an investment in additional
working capital of $6,000. The company's tax rate is 40%. Superstrut's net investment now in
the project would be:
A. $256,000
B. $242,000
C. $250,000
D. $245,000
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
Source: CMA, adapted
13. A company needs an increase in working capital of $10,000 in a project that will last 4 years.
The company's tax rate is 30% and its discount rate is 8%. The present value of the release of
the working capital at the end of the project is closest to:
A. $7,350
B. $3,000
C. $7,000
D. $5,145
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-18
14. The Dill and Gherkin Law Firm is contemplating the decision to open up a branch office across
town. The firm would sign a 5-year lease for a fully furnished office for $24,000 per year. The
lease also requires a $30,000 security deposit upon signing. This deposit will be given back at
the end of the 5-year lease term. No other amounts will need to be invested. However,
additional operating costs are expected to be $65,000 per year for the 5 years. The firm
expects to generate an additional $100,000 of revenue per year for the 5 years from the branch
office. The firm's after-tax cost of capital is 16% and its tax rate is 30%. The net present value
of this investment project is closest to:
A. $(509)
B. $5,206
C. $9,490
D. $14,206
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-19
15. A company anticipates a taxable cash expense of $80,000 in year 2 of a project. The
company's tax rate is 30% and its discount rate is 10%. The present value of this future cash
flow is closest to:
A. $(56,000)
B. $(19,835)
C. $(46,281)
D. $(24,000)
The exact answer without rounding is $(46,281).
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
16. Last year the sales at Seidelman Company were $700,000 and were all cash sales. The
company's expenses were $450,000 and were all cash expenses. The tax rate was 35%. The
after-tax net cash inflow at Seidelman last year was:
A. $700,000
B. $250,000
C. $162,500
D. $87,500
AACSB: Analytic
Blooms: Apply
Level: 1 Easy
8C-20
17. Last year the sales at Summit Company were $400,000 and were all cash sales. The expenses
at Summit were $250,000 and were all cash expenses. The tax rate was 40%. The after-tax net
cash inflow at Summit last year was:
A. $150,000
B. $60,000
C. $90,000
D. $400,000
AACSB: Analytic
Blooms: Apply
Level: 1 Easy
18. Suppose a machine costs $20,000 now, has an expected life of eight years, and will require a
$7,000 overhaul at the end of the third year. If the tax rate is 40%, then the after-tax cost of this
overhaul would be:
A. $12,000
B. $4,200
C. $8,000
D. $2,800
AACSB: Analytic
Blooms: Apply
Level: 1 Easy
8C-21
19. A company anticipates a depreciation deduction of $20,000 in year 3 of a project. The
company's tax rate is 30% and its discount rate is 14%. The present value of the annual
depreciation deductions resulting from this deduction is closest to:
A. $9,450
B. $14,000
C. $6,000
D. $4,050
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
Burry Inc. has provided the following data to be used in evaluating a proposed investment
project:
For tax purposes, the entire initial investment without any reduction for salvage value will be
depreciated over 5 years. The company uses a discount rate of 11%.
8C-22
receipts?
A. $338,000
B. $168,900
C. $394,100
D. $67,500
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
expenses?
A. $235,000
B. $217,000
C. $93,000
D. $403,000
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-23
22. By how much does the depreciation deduction reduce taxes each year in which the
depreciation deduction is taken?
A. $45,000
B. $75,000
C. $105,000
D. $32,143
Tax savings from the depreciation tax shield = Tax rate × Depreciation deduction
= 0.30 × $150,000 = $45,000
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
A. $22,500
B. $75,000
C. $52,500
D. $0
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-24
A. $250,815
B. $84,495
C. $109,800
D. $276,120
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-25
Jenny Inc. has provided the following data concerning an investment project that has been
proposed:
The company's tax rate is 30%. For tax purposes, the entire initial investment will be
depreciated over 5 years without any reduction for salvage value. The company uses a
discount rate of 14%.
A. $0
B. $31,500
C. $45,000
D. $13,500
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-26
A. $227,071
B. $58,113
C. $241,435
D. $43,749
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
Michelotti Inc. is considering an investment project that would require an initial investment of
$140,000 and that would last for 7 years. The annual cash receipts from the project would be
$105,000 and the annual cash expenses would be $47,000. The equipment used in the project
could be sold at the end of the project for a salvage value of $7,000. The company's tax rate is
30%. For tax purposes, the entire initial investment will be depreciated over 5 years without any
reduction for salvage value. The company uses a discount rate of 19%.
8C-27
receipts?
A. $73,500
B. $77,000
C. $58,000
D. $31,500
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-28
A. $11,914
B. $37,601
C. $10,464
D. $34,151
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-29
Morgado Inc. has provided the following data to be used in evaluating a proposed investment
project:
The company's tax rate is 30%. For tax purposes, the entire initial investment will be
depreciated over 5 years without any reduction for salvage value. The company uses a
discount rate of 19%.
receipts?
A. $39,000
B. $13,650
C. $54,600
D. $23,400
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
expenses?
A. $12,900
B. $30,100
C. $55,900
D. $30,000
AACSB: Analytic
8C-30
Blooms: Apply
Level: 2 Medium
31. By how much does the depreciation deduction reduce taxes each year in which the
depreciation deduction is taken?
A. $6,500
B. $15,167
C. $18,200
D. $7,800
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
A. $9,100
B. $3,900
C. $13,000
D. $0
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-31
Essay Questions
33. Sarafin Inc. is considering a project that would require an initial investment of $693,000 and
would have a useful life of 7 years. The annual cash receipts would be $416,000 and the
annual cash expenses would be $208,000. The salvage value of the assets used in the project
would be $35,000. The company's tax rate is 30%. For tax purposes, the entire initial
investment without any reduction for salvage value will be depreciated over 5 years. The
company uses a discount rate of 15%.
Required:
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-32
34. Management is considering purchasing an asset for $30,000 that would have a useful life of 5
years and no salvage value. For tax purposes, the entire original cost of the asset would be
depreciated over 5 years using the straight-line method. The asset would generate annual net
cash inflows of $21,000 throughout its useful life. The project would require additional working
capital of $4,000, which would be released at the end of the project. The company's tax rate is
40% and its discount rate is 8%.
Required:
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-33
35. A company is considering purchasing an asset for $50,000 that would have a useful life of 8
years and would have a salvage value of $5,000. For tax purposes, the entire original cost of
the asset would be depreciated over 8 years using the straight-line method and the salvage
value would be ignored. The asset would generate annual net cash inflows of $26,000
throughout its useful life. The project would require additional working capital of $8,000, which
would be released at the end of the project. The company's tax rate is 40% and its discount
rate is 13%.
Required:
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-34
36. Eisenbeis Inc. has provided the following data concerning a proposed investment project:
The company's tax rate is 30%. For tax purposes, the entire initial investment without any
reduction for salvage value will be depreciated over 7 years. The company uses a discount rate
of 13%.
Required:
AACSB: Analytic
Blooms: Apply
Level: 2 Medium
8C-35
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Professional Exam Adapted

Income Taxes in Capital Budgeting Decisions

True / False Questions

3. Not all cash inflows are taxable.

Multiple Choice Questions

A. an increase in the cost of capital.

A. one minus the tax rate times the amount of deprecation.

7. The after-tax cost of a deductible cash expense is:

A. The amount of the cash expense.

24. The net present value of the project is closest to:

26. The net present value of the project is closest to:

28. The net present value of the project is closest to:

Compute the net present value of the project.

What is the net present value of the asset?

What is the net present value of the asset?

Compute the net present value of the project.

True / False Questions

AACSB: Reflective Thinking

AACSB: Reflective Thinking

3. Not all cash inflows are taxable.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

A. an increase in the cost of capital.

AACSB: Reflective Thinking

6. Depreciation expense reduces income taxes by an amount equal to:

A. one minus the tax rate times the amount of deprecation.

AACSB: Reflective Thinking

7. The after-tax cost of a deductible cash expense is:

A. The amount of the cash expense.

AACSB: Reflective Thinking

The answer without rounding error is $17,355.

After-tax cost = (1 - Tax rate) × Tax-deductible cash expense

The exact answer without rounding is $(46,281).

Compute the net present value of the project.

What is the net present value of the asset?

What is the net present value of the asset?

Compute the net present value of the project.

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