Deck 14: Capital Investment Decisions: the Impact of Capital Rationing, Taxation, Inflation and Risk

Question 1

Tax savings from tax allowable depreciation (i.e. writing down allowances) is calculated as

A)Depreciation deduction * Tax rate.
B)Depreciation deduction * (1 - Tax rate).
C)Asset cost *MACRS percentage.
D)Depreciation is not a cash flow; therefore, there is no tax savings from depreciation.

Answer 1

Depreciation deduction * Tax rate.

Question 2

Clemens Company is considering the purchase of a new machine for £160,000. The machine would generate an annual cash flow before depreciation and taxes of £62,588 for four years. At the end of four years, the machine would have no salvage value. The company's cost of capital is 12 per cent. The company claims capital allowances using straight-line depreciation and has a 40 per cent tax rate. What is the net present value for the machine?

A)£162,640
B)£2,640
C)£30,080
D)(£45,952)

Answer 2

B

Question 3

A firm has £1,000,000 of long-term bonds paying 8 per cent interest and £3,000,000 of common stock. The firm is considered to be of average risk with the return to the stockholders estimated to be 12 per cent. If the company's tax rate is 35 per cent, what is the firm's weighted average cost of capital?

A)11.00%
B)7.15%
C)10.30%
D)none of the above

Answer 3

C

Question 4

The annual tax deduction for depreciation:

A)is not accompanied by a direct cash outlay.
B)provides an indirect cash inflow by reducing taxes.
C)multiplied by the tax rate equals the depreciation tax shield (i.e. the tax benefit from capital allowances.
D)all of the above

Question 5

Which of the following is least likely to affect taxes as a result of a capital budgeting decision?

A)an increase in operating income
B)the disposition of an old asset that is fully depreciated and worthless
C)salvage value of a new asset
D)depreciation of a new asset

Question 6

Which of the following is included in calculating the weighted average cost of capital?

A)interest rate paid on borrowed money
B)average return earned by stockholders
C)taxes
D)all of the above

Question 7

If the tax rate is 35 per cent, a tax depreciation deduction (WDA) of £75,000 would result in a tax savings of

A)£25,000.
B)£26,250.
C)£48,750.
D)£50,000.

Question 8

If an asset is sold for more than its tax written down value,

A)a gain results and additional taxes are incurred.
B)a gain and tax savings result.
C)a loss results and additional taxes are incurred.
D)a loss and tax savings result.

Question 9

Houston Ltd.is considering an investment in equipment for £45,000. Data related to the investment are as follows: $$\begin{array}{l}&\text { Cash Flow before }\\\text { Year } & \text { Depreciation and Taxes } \\\hline 1 & £ 30,000 \\2 & 30,000 \\3 & 30,000 \\4 & 30,000 \\5 & 30,000\end{array}$$ Cost of capital is 18 per cent. Houston claims capital allowances (WDV's) using the straight-line method of depreciation. In addition, their tax rate is 40 per cent, and the life of the equipment is five years with no salvage value.
What is the net present value of the investment?

A)£67,543
B)£22,543
C)£48,810
D)£11,286

Question 10

Springer Company is considering the purchase of a new machine for £80,000. The machine would generate an annual cash flow before depreciation and taxes of £28,778 for five years. At the end of five years, the machine would have no salvage value. The company's cost of capital is 12 per cent. The company claims capital allowances based on straight-line depreciation and has a 40 per cent tax rate. What is the net present value for the machine?

A)£5,318
B)£-0-
C)£85,318
D)£23,744

Question 11

Young Company has a tax rate of 40 per cent. Information for the company is as follows: $\begin{array}{lrc}& \text { Amount } & \text { After-tax Cost } \\ \text { Mortgage bonds } & £ 1,000,000 & 0.048 \\\text { Unsecured bonds } & 3,000,000 & 0.050 \\\text { Common stock (ordinary share capital) }& 6,000,000 & 0.150\end{array}$ What is the weighted cost of capital?

A)0.1098
B)0.2480
C)0.0827
D)0.0366

Question 12

____ is the process of altering key variables to assess the effect on the original outcome.

A)Alteration analysis
B)Experimentation
C)Net present value
D)Sensitivity analysis

Question 13

A follow-up analysis of an investment decision is called a(n)

A)performance review.
B)feedback session.
C)audit.
D)postaudit.

Question 14

A company has pre-tax cash inflows from operations of £500,000. If the company's tax rate is 35 per cent, the company's after-tax net cash inflow from operations would be

A)£166,667.
B)£175,000.
C)£325,000.
D)£333,333.

Question 15

Which of the following is a common adjustment to net present value models to incorporate risks inherent in an investment project?

A)The discount rate used in the analysis can be increased.
B)The payback period can be increased.
C)A lower discount rate can be used.
D)Risk is never considered in a model since it can not be quantified.

Question 16

If the tax rate is 40 per cent and a company has pre-tax cash inflows from operations of £600,000, the company's after-tax net cash inflow from operations would be

A)£396,000.
B)£360,000.
C)£240,000.
D)£204,000.

Question 17

Jolly Ltd.is considering an investment in equipment for £25,000. Data related to the investment are as follows: $\begin{array}{cc}&\text { Cash Flow before }\\\text { Year } & \text { Depreciation and Taxes } \\\hline 1 & £ 12,500 \\2 & 12,500 \\3 & 12,500 \\4 & 12,500\end{array}$
Jolly claims capital allowances using the straight-line method of depreciation. In addition, its tax rate is 40 per cent, and the life of the equipment is four years with no salvage value. Cost of capital is 12 per cent. What is the net present value of the investment?

A)£30,370
B)£(2,222)
C)£12,962
D)£5,370

Question 18

If an asset is sold for less than its tax written down value,

A)a gain results and additional taxes are incurred.
B)a gain and tax savings result.
C)a loss results and additional taxes are incurred.
D)a loss and tax savings result.

Question 19

A firm has £2,000,000 of long-term bonds paying 8 per cent interest and £8,000,000 of common stock. The firm is considered to be of average risk with the return to the stockholders estimated to be 14 per cent. If the company's tax rate is 40 per cent, what is the firm's weighted average cost of capital?

A)12.80%
B)12.16%
C)8.32%
D)none of the above

Question 20

The depreciation tax shield is:

A)the increase in taxes due to the deductibility of depreciation from taxable revenues.
B)the reduction in taxes due to the deductibility of depreciation from taxable revenues.
C)the fact that equipment is not depreciable for accounting purposes.
D)the fact that equipment is not depreciable for tax purposes.

Question 21

A postaudit compares

A)estimated benefits and costs with budgeted benefits and cost.
B)estimated benefits with estimated costs.
C)actual benefits with actual costs.
D)actual benefits and costs with estimated benefits and costs.

Question 22

Why should a company conduct postaudits of its investment projects?

A)It ensures that investment resources were used wisely.
B)Accountable managers would make goal-congruent decisions.
C)It provides feedback for future decision making.
D)all of the above