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1. Sale of an asset for less than book value creates an operating loss which effectively reduces the company's taxes by an amount equal to _________ times _________ . a. one-half the loss, the company's marginal tax rate b. the loss, one minus the company's marginal tax rate c. one-half the loss, one minus the company's marginal tax rate d. the loss, the company's marginal tax rate > d Topic: Recovery of after-tax salvage value 2. There is neither a gain or a loss on the sale of a depreciable asset for an amount exactly equal to its ________ . a. acquisition cost b. tax book value c. opportunity cost d. historical cost > b Topic: Recovery of after-tax salvage value 3. Which of the following would not be classified as a capital expenditure for decision- making purposes? a. purchase of a building b. investment in a management training program c. purchase of 90-day Treasury Bills d. development of a major advertising campaign > c Topic: Introduction 4. A firm's cost of capital is a. an important financial ratio b. equal to 10 percent c. rarely used in practice d. an important input in the capital budgeting process > d Topic: Cost of capital 5. The decision by the Municipal Transportation Authority to either refurbish existing buses, to buy new large buses, or to supplement the existing fleet with mini-buses is an example of a. independent projects b. mutually exclusive projects c. contingent projects d. separable projects > b Topic: How projects are classified 6. Which of the following is a basic principle when estimating a project's cash flows? a. cash flows should be measured on a pretax basis b. cash flows should ignore depreciation because it is a non-cash charge c. only direct effects of a project should be included in cash flow calculations d. cash flows should be measured on an incremental basis > d Topic: Net operating cash flows 7. Raider Productions has to decide whether to build its warehouse in Dallas or Houston. This decision falls into the class of a. independent projects b. mutually exclusive projects c. contingent projects d. marginal projects > b Topic: How projects are classified 8. When a firm sells an asset for __________, it realizes a capital gain and must pay income taxes on it. a. book value b. less than book value c. more than book value but less than original cost d. more than its original cost > d Topic: Recovery of after-tax salvage value 9. In estimating the net investment, an outlay that has already been made is known as a (n) __________. a. sunk cost b. cash outflow c. opportunity cost d. expansion cost > a Topic: Principles of estimating cash flows 10. Depreciation _______ reported profits and it _______ taxes paid by a firm. a. increases, reduces b. reduces, reduces c. reduces, increases d. increases, increases > b Topic: Net operating cash flows 11. The ________ the amount of depreciation charged in a period, the __________ will be the firm's taxable income. a. greater, lower b. lower, lower c. lower, greater d. greater, higher > a Topic: Depreciation 12. Depreciation a. does not affect cash flows b. does not affect profits c. is not a cash outflow d. is a cash inflow > c Topic: Depreciation 13. A(n) ________ project is one whose acceptance is dependent on the adoption of one or more other projects. a. contingent b. mutually exclusive c. independent d. perfectly correlated > a Topic: How projects are classified 14, The net investment calculation for an ________ project normally includes ________. a. asset expansion; pretax proceeds from the sale of the old asset b. asset replacement; pretax proceeds from the sale of the old asset c. asset expansion; after-tax proceeds from the sale of the old asset d. asset replacement; after-tax proceeds from the sale of the old asset > d Topic: Calculating the net investment 15. There is a capital gain on the sale of an asset for ________. a. more than its original cost b. more than its book value but less than its original cost c. a and b d. none of the above > a Topic: Recovery of after-tax salvage value 16. Capital expenditure projects may be classified in all the following types except a. growth opportunities b. required to meet legal requirements c. cost reduction opportunities d. capital rationing > d Topic: Classifying investment projects 17. A drill press costs $30,000 and is expected to have a 10 year life. The drill press will be depreciated on a straight-line basis over 10 years to a zero estimated salvage value. This machine is expected to reduce the firm's cash operating costs by $4,500 per year. If the firm is in the 40 percent marginal tax bracket, determine the annual net cash flows generated by the drill press. a. $4,500 b. $900 c. $5,700 d. $3,900 > d Problem type: Net cash flow calculation Solution: NCF = $(0 - ($-4,500) - $3,000)(1 - 0.40) + $3,000 = $3,900 18. An investment project is expected to generate earnings before taxes (EBT) of $60,000 per year. Annual depreciation from the project is $30,000 and the firm's tax rate is 40 percent. Determine the project's annual net cash flows. a. $48,000 b. $66,000 c. $36,000 d. None of the above > b Problem type: Net cash flow calculation Solution: NCF = $60,000(1 - 0.40) + $30,000 = $66,000 19. Little Giant is building a manufacturing plant that will require a cash outlay of $300,000 for the initial purchase of a building, $450,000 for remodeling the first year, and $710,00 for new equipment in the second year. If the firm's cost of capital is 12 percent, what is the present value of the net investment at time 0? a. $1,460,000 b. $1,132,070 c. $1,267,720 d. $300,000 > c Problem type: Net investment calculation Solution: PV of NINV = $300,000 + $450,000 (0.893) + $710,000(0.797) = $1,267,720 20. In Step Video is considering expanding its video rental library to 8,000 tapes. The purchase price of the additional videos will be $80,000 and the shipping cost is another $4,000. To house the tapes, the owner will have to spend another $10,000 for display shelves, increase net working capital by $5,000, and interest expenses will add another $8,000 to the operating cost. What is the net investment to In Step Video for this project? a. $95,000 b. $99,000 c. $84,000 d. $107,000 > b Problem type: Net investment calculation Solution: NINV = $80,000 + $4,000 + $10,000 +$5,000 = $99,000 21. What is the net investment for an extruder that costs $42,000, if shipping costs are $1,500 and installation is $4,800? Assume this efficient machine is replacing an older extruder with a book and market value of zero. The replacement investment will reduce operating costs by $6,600 a year. a. $48,300 b. $54,900 c. $43,500 d. None of the above > a Problem type: Net investment calculation Solution: NINV = $42,000 + $1,500 + $4,800 = $48,300 22. Shunt Technology will spend $800,000 on a piece of equipment that will manufacture fine wire for the electronics industries. The shipping and installation charges will be $240,000 and net working capital will increase $48,000. The equipment will replace an existing machine that has a salvage value of $75,000 and a book value of $125,000. If Shunt has a current marginal tax rate of 34 percent, what is the net investment? a. $1,030,000 b. $1,163,000 c. $1,033,000 d. $996,000 > d Problem type: Net investment calculation Solution: NINV = $800,000 + $240,000 + $48,000 - $75,000 - $17,000* = $996,000 * ($125,000 - $75,000)(0.34) = $17,000 tax saving on loss 23. Capital Foods purchased an oven 5 years ago for $45,000. The oven is being depreciated over its estimated 10 year life using the straight line method to a salvage value of $5,000. Capital is planning to replace the oven with a more automated one that will cost $150,000 installed. If the old oven can be sold for $30,000, what is the tax liability? Assume a marginal tax rate of 40 percent. a. $900 b. $2,000 c. $127,000 d. None of the above > b Problem type: Tax effects of salvage Solution: Book Value = $45,000 - 5($45,000 - $5,000)/10 = $25,000 Tax liability = ($30,000 - $25,000)(0.4) = $2,000 24. The management of Jasper Equipment Company is planning to purchase a new milling machine that will cost $160,000 installed. The old milling machine has been fully depreciated but can be sold for $15,000. The new machine will be depreciated on a straight line basis over its 10 year economic life to an estimated salvage value of $10,000. If this milling machine will save Jasper $20,000 a year in production expenses, what are the annual net cash flows associated with the purchase of this machine? Assume a marginal tax rate of 40 percent. a. $15,000 b. $18,000 c. $27,000 d. None of the above > b Problem type: Net cash flow calculation Solution: Depreciation/yr. = ($160,000 - $10,000)/10 = $15,000 NCF = ($20,000 - $15,000)(1 - 0.4) + $15,000 = $18,000 25. Jim Bo's currently has annual cash revenues of $240,000 and annual operating expenses of $185,000 including $35,000 in depreciation. The firm's marginal tax rate is 40 percent. A new cutting machine can be purchased for $120,000 that that will increase revenues by $50,000 per year while operating expenses would increase to $205,000, including $42,000 in depreciation. Compute Jim Bo's annual incremental after-tax net cash flows. a. $25,000 b. $20,800 c. $93,000 d. $19,000 > a Problem type: Net cash flow calculation Solution: NCF = ($50,000 - $20,000)(1 - 0.4) + $7,000 = $25,000 26. Moon Pie Company is considering automated baking equipment that costs $500,000 installed and would replace the present hand-made production method. The present equipment has a zero book and salvage value. The new equipment will not increase revenues but will reduce operating costs from a current level of $600,000 to $300,000 per year. The depreciation of the new equipment will be $73,000 per year. What are the annual incremental net cash flows? Assume a marginal tax rate of 40 percent. a. $296,800 b. $136,200 c. $192,200 d. $209,200 > d Problem type: Net cash flow calculation Solution: NCF = ($300,000 - $73,000)(1 - 0.4) + $73,000 = $209,200 27. LISP Inc. is planning to purchase a new mixer/dubber for $50,000. The new equipment will replace an older mixer that has been fully depreciated but has a salvage value of $5,000. Compute the net investment required for this project. Assume a marginal tax rate of 40 percent. a. $47,000 b. $45,000 c. $48,000 d. None of the above > a Problem type: Net investment calculation Solution: NINV = $50,000 - $5,000 + $5,000(0.4) = $47,000 28. What is the net investment required for a pitting machine that will cost $35,000 including installation? The machine replaces a machine that cost $5,000 when purchased five years ago. The old machine has been fully depreciated but has a market value of $6,000. Assume the marginal tax rate is 40 percent. a. $29,000 b. $31,400 c. $32,600 d. None of the above > b Problem type: Net investment calculation Solution: NINV = $35,000 - $6,000 + $6,000(0.4) = $31,400 29. Allen Company is considering an investment project that is expected to generate $100,000 in annual earnings before taxes. Annual depreciation will be $50,000. Allen's marginal tax rate is 40%. Determine the project's annual net cash flows. a. $150,000 b. $110,000 c. $90,000 d. $60,000 > b Problem type: Net cash flow Solution: NCF = DEBT (1 - T) + DDep = $100,000 (1 - 0.40) + $50,000 = $110,000 30. Baker Company is considering an investment in a new metal lathe. If the new lathe is purchased, revenues will increase by $5,000 per year and cash operating costs will decline by $10,000 per year. The lathe will cost $60,000 and will be depreciated on a straight-line basis over 10 years to a zero estimated salvage value. Baker's marginal tax rate is 40%. Determine the annual net cash flows generated by the lathe. a. $11,400 b. $9,000 c. $600 d. $5,400 > a Problem type: Net cash flow Solution: NCF = (DR - D0 - DDep) (1 - T) + DDep = [$5,000 - (-$10,000) - $6,000] (1 - 0.40) + $6,000 = $11,400 31. Basin Manufacturing (40% marginal tax rate) is considering a plant expansion project. The equipment will cost $100,000 and will require an additional $10,000 for delivery and installation. The expansion also will require Basin to increase immediately its net working capital by $25,000. The expansion is expected to generate revenues of $150,000 per year. Calculate the project's net investment. a. $ 81,000 b. $125,000 c. $131,000 d. None of the above > d Problem type: Net investment Solution: NINV = $100,000 + $10,000 + $25,000 = $135,000 32. Felix Industries purchased a grinder 5 years ago for $15,000. It is being depreciated on a straight-line basis over 15 years to an estimated salvage value of zero. It could be sold now for $6,000. The firm is considering selling it and purchasing a new one. The new grinder would cost $25,000 installed and would be depreciated on a straight-line basis over 10 years to a zero estimated salvage value. The company's marginal tax rate is 40%. Determine the net investment if the old grinder is sold and the new one purchased. a. $19,000 b. $16,600 c. $17,400 d. none of the above/cannot be computed > c Problem type: Net investment Solution: Cost of grinder (installed) $25,000 Proceeds from sale of old grinder - 6,000 Net investment before taxes $19,000 Tax saving on loss ($10,000 - $6,000 = $4,000) from sale of old grinder ($4,000 x 0.40) -1,600 Net investment (NINV) $17,400 33. The Johnson Drum Company is planning to build a new factory. The purchase of the land, building the plant, and installation of equipment will take place over a two year period. The following are planned cash outflows: Year Cash Outflow 0 $3,500,000 1 $4,750,000 2 $6,100,000 Johnson Drum's cost of capital is 14%, and its marginal tax rate is 35%. What is the NINV measured in present value terms today? a. $14,350,000 b. $12,356,650 c. $ 9,327,500 d. $ 8,035,788 > b Problem type: Net investment determination Solution: Year Cash Outflow PVIF PV of NINV 0 $3,500,000 1.000 3,500,000 1 $4,750,000 0.877 4,165,750 2 $6,100,000 0.769 4,690,900 $12,356,650 34. The Johnson Drum Company is planning to build a new factory. The purchase of the land, building the plant, and installation of equipment will take place over a two year period. The following are planned cash outflows: Year Cash Outflow 0 $3,500,000 1 $4,750,000 2 $6,100,000 Johnson Drum's cost of capital is 14%, and its marginal tax rate is 35%. What is the NINV measured in present value terms today? a. $14,350,000 b. $12,356,650 c. $ 9,327,500 d. $ 8,035,788 > b Problem type: Net investment determination Solution: Year Cash Outflow PVIF PV of NINV 0 $3,500,000 1.000 3,500,000 1 $4,750,000 0.877 4,165,750 2 $6,100,000 0.769 4,690,900 $12,356,650 35. Anderson Clayton will purchase a new pellet mill that replace an older, less efficient, mill. The new mill costs $360,000 and shipping costs are $10,000. Improving the steam lines to the new mill will cost an additional $22,000. The old mill has a book value of $25,000 and can be sold for $12,000. The installation of the new mill will cause inventories to increase by $8,000, accounts receivable will go up $20,000, and accounts payable will increase $10,000. If Anderson Clayton has a marginal tax rate of 40%, what is the NINV for the new mill? a. $392,800 b. $412,800 c. $374,800 d. $398,000 > a Problem type: Net investment determination Solution: Installed cost $392,000 Less: salvage - 12,000 Less: tax savings on sale - 5,200 Add: increase in NWC 18,000 $392,800