Question 1

Consider the following statements about depreciation tax shields:
I. A depreciation tax shield provides distinct benefits to a business.
II. A depreciation tax shield should be ignored when doing a net-present-value analysis.
III. A depreciation tax shield can occur in more than one year.
Which of the above statements is (are) correct?

Accepted Answer

I. A depreciation tax shield does provide distinct benefits to a business by reducing taxable income, which in turn reduces the taxes payable. III. A depreciation tax shield can indeed occur over multiple years as assets are depreciated over their useful lives, not just in a single year. II is incorrect because depreciation tax shields should not be ignored in net-present-value analysis; they are an important factor in determining the after-tax cash flows of a project.

Question 2

Consider the following statements about the investment in working capital in a capital budgeting analysis:
I. Working capital often increases as the result of higher balances in accounts receivable or inventory necessary to support a project.
II. Working capital increases are sources of cash and should be included in a discounted-cash-flow analysis.
III. The time 0 cash investment in working capital is included in a discounted-cash-flow analysis as a cash outflow.
Which of the above statements is (are) correct?

Accepted Answer

I. This statement is correct because as a project grows, it often requires more inventory and may extend more credit to its customers, leading to higher accounts receivable. Both of these factors increase the need for working capital.III. This statement is correct because the initial investment in working capital (such as additional inventory or accounts receivable) is considered a cash outflow at the start of a project. It is a necessary investment to get the project up and running.

Question 3

Workman Company is considering a five-year project that requires a typical investment in working capital, in this case, $100,000. Consider the following statements about this situation:
I. Workman should include a $100,000 outflow that occurs at time 0 in a discounted-cash-flow analysis.
II. Workman should include separate $100,000 outflows in each year of the project's five-year life.
III. Workman should include a $100,000 recovery of its working-capital investment in year 5 of a discounted-cash-flow analysis.
Which of the above statements is (are) correct?

Accepted Answer

In discounted cash flow analysis, the initial investment in working capital is considered an outflow at time 0 (statement I), and the recovery of this investment at the end of the project's life is considered an inflow (statement III). Separate outflows in each year (statement II) are not how working capital is typically treated in such analyses.

Question 4

A depreciation tax shield is a(n):

Accepted Answer

A depreciation tax shield refers to the reduction in income tax that a company experiences due to the depreciation expense. Depreciation expense reduces taxable income, which in turn reduces the amount of income tax a company owes.

Question 5

The Modified Accelerated Cost Recovery System (MACRS) assumes that, on average, assets will be placed in service:

Accepted Answer

MACRS assumes assets are placed in service halfway through the tax year, which allows for a simplified calculation of depreciation in the first year the asset is in service.

Question 6

In 10 years, Hopkins Company plans to receive $9,000 cash from the sale of a machine that has a $5,000 book value.

If the firm is subject to a 30% income tax rate and has an 8% after-tax hurdle rate, the correct discounted net cash flow would be:

Accepted Answer

The answer of In 10 years, Hopkins Company plans to...

Question 7

Which of the following is the proper calculation of a company's depreciation tax shield?

Accepted Answer

The depreciation tax shield is calculated by multiplying the depreciation expense by the tax rate. This represents the amount of tax saved due to the depreciation deduction.

Question 8

A machine was sold in December 20x3 for $9,000. It was purchased in January 20x1 for $15,000, and depreciation of $12,000 was recorded from the date of purchase through the date of disposal. Assuming a 40% income tax rate, the after-tax cash inflow at the time of sale is:

Accepted Answer

The after-tax cash inflow can be calculated by first determining the gain or loss on the sale of the machine. The machine's book value at the time of sale is its original cost ($15,000) minus accumulated depreciation ($12,000), which equals $3,000. The sale price ($9,000) minus the book value ($3,000) results in a gain of $6,000. The tax on the gain is 40% of $6,000, which equals $2,400. Therefore, the after-tax cash inflow is the sale price ($9,000) minus the tax on the gain ($2,400), which equals $6,600.

Question 9

A new machine is expected to produce a MACRS deduction in three years of $50,000.

If the company has a 12% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow to include in an acquisition analysis would be:

Accepted Answer

The answer of A new machine is expected to produce...

Question 10

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used straight-line depreciation and changes to the Modified Accelerated Cost Recovery System (MACRS), the investment's net present value will:

Accepted Answer

Switching from straight-line depreciation to MACRS allows for more accelerated depreciation in the early years of an asset's life. This results in higher tax deductions early on, which increases the present value of tax shields and, consequently, the investment's net present value.

Question 11

If a company desires to be in compliance with current income tax law and write off the cost of its assets rapidly, the firm would use:

Accepted Answer

The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system in the United States, which allows for accelerated depreciation, enabling companies to write off the cost of their assets more rapidly in compliance with tax laws.

Question 12

Use the following information to answer the following Questions
Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate.
-The net after-tax cash flow of the disposal is:

Accepted Answer

The answer of Use the following information to answer the...

Question 13

In eight years, Shu Company plans to receive $11,000 cash from the sale of a machine that has a $16,000 book value.

If the firm is subject to a 30% income tax rate and has a 12% after-tax hurdle rate, the correct discounted net cash flow would be:

Accepted Answer

The answer of In eight years, Shu Company plans to...

Question 14

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used Modified Accelerated Cost Recovery System (MACRS) and changes to the straight-line depreciation, the investment's net present value will:

Accepted Answer

Switching from MACRS to straight-line depreciation typically results in lower depreciation expenses in the early years of an asset's life and higher expenses in the later years. This change delays tax deductions, leading to higher taxes in the early years and reducing the present value of the tax shields, thus decreasing the investment's net present value (NPV).

Question 15

Young Company received $18,000 cash from the sale of a machine that had a $13,000 book value. If the company is subject to a 30% income tax rate, the net cash flow to use in a discounted-cash-flow analysis would be:

Accepted Answer

The net cash flow is calculated by taking the cash received ($18,000) minus the tax on the gain. The gain is $5,000 ($18,000 - $13,000), and the tax on the gain is $1,500 (30% of $5,000). Therefore, the net cash flow is $18,000 - $1,500 = $16,500.

Question 16

Donata Company purchased equipment for $30,000 in December 20x1. The equipment is expected to generate $10,000 per year of additional revenue and incur $2,000 per year of additional cash expenses, beginning in 20x2. Under MACRS, depreciation in 20x2 will be $3,000. If the firm's income tax rate is 40%, the after-tax cash flow in 20x2 would be:

Accepted Answer

The answer of Donata Company purchased equipment for $30,000 in...

Question 17

Julio Company purchased a $200,000 machine that has a four-year life and no salvage value. The company uses straight-line depreciation on all asset acquisitions and is subject to a 30% tax rate. The proper cash flow to show in a discounted-cash-flow analysis as occurring at time 0 would be:

Accepted Answer

The initial cash flow at time 0 for the purchase of the machine would be the full purchase price of $200,000, which is an outflow, hence $(200,000). Straight-line depreciation and tax effects are not considered in the initial cash outlay but affect future cash flows.

Question 18

A machine is expected to produce annual savings in cash operating costs of $400,000 for the next six years.

If the company has a 10% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow would be:

Accepted Answer

The answer of A machine is expected to produce annual...

Question 19

A company that uses accelerated depreciation:

Accepted Answer

Accelerated depreciation methods, such as the double-declining balance method, allow a company to write off a larger portion of an asset's cost in the early years of its useful life, compared to the straight-line method. This front-loading of depreciation expenses can lead to more tax benefits earlier in the asset's life, as higher depreciation expenses reduce taxable income. This practice is in compliance with generally accepted accounting principles (GAAP), making options B and D incorrect.

Question 20

Use the following information to answer the following Questions
Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate.
-The loss on disposal would be:

Accepted Answer

The book value of the asset is calculated as the cost minus accumulated depreciation, which is $5,000 - $2,000 = $3,000. Selling the asset for $2,500 results in a loss of $3,000 - $2,500 = $500.

Quiz 16: Capital Expenditure Decisions

A depreciation tax shield is a(n) :

The Modified Accelerated Cost Recovery System (MACRS) assumes that, on average, assets will be placed in service:

In 10 years, Hopkins Company plans to receive $9,000 cash from the sale of a machine that has a $5,000 book value. If the firm is subject to a 30% income tax rate and has an 8% after-tax hurdle rate, the correct discounted net cash flow would be:

Which of the following is the proper calculation of a company's depreciation tax shield?

A machine was sold in December 20x3 for $9,000. It was purchased in January 20x1 for $15,000, and depreciation of $12,000 was recorded from the date of purchase through the date of disposal. Assuming a 40% income tax rate, the after-tax cash inflow at the time of sale is:

A new machine is expected to produce a MACRS deduction in three years of $50,000. If the company has a 12% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow to include in an acquisition analysis would be:

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used straight-line depreciation and changes to the Modified Accelerated Cost Recovery System (MACRS) , the investment's net present value will:

If a company desires to be in compliance with current income tax law and write off the cost of its assets rapidly, the firm would use:

Use the following information to answer the following Questions Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate. -The net after-tax cash flow of the disposal is:

In eight years, Shu Company plans to receive $11,000 cash from the sale of a machine that has a $16,000 book value. If the firm is subject to a 30% income tax rate and has a 12% after-tax hurdle rate, the correct discounted net cash flow would be:

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used Modified Accelerated Cost Recovery System (MACRS) and changes to the straight-line depreciation, the investment's net present value will:

Young Company received $18,000 cash from the sale of a machine that had a $13,000 book value. If the company is subject to a 30% income tax rate, the net cash flow to use in a discounted-cash-flow analysis would be:

Julio Company purchased a $200,000 machine that has a four-year life and no salvage value. The company uses straight-line depreciation on all asset acquisitions and is subject to a 30% tax rate. The proper cash flow to show in a discounted-cash-flow analysis as occurring at time 0 would be:

A machine is expected to produce annual savings in cash operating costs of $400,000 for the next six years. If the company has a 10% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow would be:

A company that uses accelerated depreciation:

Use the following information to answer the following Questions Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate. -The loss on disposal would be: