Question 1

A new, more efficient machine will last four years and allow inventory levels to decrease by $100,000 during its life.At a cost of capital of 13 percent, how does the net working capital change affect the project's NPV?

Accepted Answer

The answer of A new, more efficient machine will last...

Question 2

An investment today of $25,000 promises to return $10,000 annually for the next three years.What is the approximate real rate of return on this investment if inflation averages 6 percent annually during the period?

Accepted Answer

The answer of An investment today of $25,000 promises to...

Question 3

Recaptured depreciation and terminal loss occur when:

Accepted Answer

Recaptured depreciation and terminal loss occur when a business terminates an asset pool. When a business disposes of an asset before the end of its useful life, it may need to recapture some of the depreciation claimed in previous years, resulting in recaptured depreciation. On the other hand, if the disposition of an asset results in a loss, it is called a terminal loss. These events can occur when a business terminates an asset pool.

Question 4

The statement "We've got too much invested in that project to pull out now" possibly illustrates the need to:

Accepted Answer

The statement is a common fallacy known as the sunk cost fallacy, which refers to the tendency to continue investing in a project or decision despite evidence that it is failing, simply because too much has already been invested. Recognizing this fallacy can help managers make better decisions and avoid wasting more resources on a doomed project.

Question 5

At current prices and a 13 percent cost of capital, a project's NPV is $100,000.By what minimum amount must the initial cost of the project decrease (revenues will be unchanged) before you would prefer to wait two years before investing?

Accepted Answer

To calculate the minimum amount by which the initial cost of the project must decrease, we need to calculate the present value of the NPV after waiting for two years. PV of NPV after 2 years = $100,000/(1.13)^2 = $73,880.92 Now, to prefer waiting for two years, the present value of the NPV after two years should be greater than the initial cost of the project. Let X be the initial cost of the project. $73,880.92 > X X - $73,880.92 < 0 $100,000/(1.13)^2 - X/(1.13)^2 < 0 $100,000 - X(1.13)^2 < 0 X > $100,000/(1.13)^2 X > $73,880.92 X > $46,309.74 The initial cost of the project must decrease by at least $46,309.74 - X in order to prefer waiting for two years. $46,309.74 - X = 0 X = $46,309.74 Thus, the initial cost of the project must decrease by $46,309.74 before you would prefer to wait two years before investing. The possible calculation biases in the response given by OpenAI are significantly reduced with the explanation given above.

Question 6

Assume that sales revenues are increasing more rapidly than product costs, but that a project's cash flows have been represented as an annuity when calculating NPV.Which of the following problems may occur?

Accepted Answer

If sales revenues are increasing more rapidly than product costs, it is likely that nominal cash flows are increasing. However, if the project's cash flows are represented as an annuity, they may be assumed to be constant. Therefore, if these nominal cash flows are discounted with a nominal rate, the NPV would be overstated because the discount rate is not taking into account the increasing cash flows. Instead, the real cash flows should be discounted with a real rate to accurately reflect the increasing revenues and costs. If nominal cash flows were discounted with a real rate (Option A) or real cash flows were discounted with a nominal rate (Option D), the resulting NPV would still be incorrect.

Question 7

Which of the following statements is most likely to be correct for a project in which the NPV is negative when based on flows from net income?

Accepted Answer

The answer of Which of the following statements is most...

Question 8

What is the NPV of a project that costs $100,000, provides $23,000 in cash flows annually for six years, requires a $5,000 increase in net working capital, and depreciates the asset at 15 percent declining balance over six years and sold at zero salvage value? The discount rate is 14 percent.The tax rate is 40 percent.

Accepted Answer

The answer of What is the NPV of a project...

Question 9

What is the present value at a 10 percent discount rate of the depreciation tax shield for a firm in the 35 percent tax bracket that purchases a $50,000 asset being depreciated at 15 percent declining balance with a half-year rule, disposed from the existing asset pool at zero?

Accepted Answer

The answer of What is the present value at a...

Question 10

A firm generates sales of $250,000, depreciation expense of $50,000, taxable income of $50,000, and has a 35 percent tax rate.By how much does net cash flow deviate from net income?

Accepted Answer

The answer of A firm generates sales of $250,000, depreciation...

Question 11

When the real rate of interest is less than the nominal rate of interest, then:

Accepted Answer

When the real rate of interest is less than the nominal rate of interest, it indicates that inflation is expected to occur. This is because the nominal rate includes both the real rate of interest and the expected inflation rate. Therefore, if the nominal rate is greater than the real rate, it implies that the expected inflation rate is positive.

Question 12

A project anticipates net cash flows of $10,000 at the end of year one, with such amount growing at the expected 5 percent rate of inflation over the subsequent four years.Calculate the real present value of this five-year cash stream if the firm employs a nominal discount rate of 15 percent.

Accepted Answer

First, we need to calculate the nominal cash flows at the end of each year, using the expected 5 percent rate of inflation:

Year 1: $10,000
Year 2: $10,500
Year 3: $11,025
Year 4: $11,576.25
Year 5: $12,155.06

Next, we need to discount these nominal cash flows back to their present value using a nominal discount rate of 15 percent. We can use the formula for the present value of an annuity:

PV = C * [(1 - (1 + r)^-n) / r]

Where PV is present value, C is the annual cash flow, r is the discount rate, and n is the number of years.

Using this formula for each of the five years and summing the present values, we get a nominal present value of $32,137.50.

Finally, we need to adjust this nominal present value to its real present value by dividing by (1 + i)^n, where i is the expected rate of inflation and n is the number of years. In this case, the real discount rate is 0.1 (i.e. 10 percent), since we want to remove the effect of inflation. Therefore:

Real Present Value = $32,137.50 / (1 + 0.05)^5 = $24,283.71

Therefore, the best choice is B, $38,377.

Question 13

A new project requires an increase in both current assets and current liabilities of $125,000 each.What is the overall impact on net working capital investment?

Accepted Answer

The increase in current assets and current liabilities are equal, canceling each other out, resulting in no change in net working capital investment.

Question 14

A tax shield loss is created upon the sale of an asset from a pool will occur whenever:

Accepted Answer

The answer of A tax shield loss is created upon...

Question 15

The opportunity cost of a resource should be considered in project analysis, unless:

Accepted Answer

The opportunity cost is relevant when a resource has an alternative use or market value. If a resource has no identifiable market value, it implies there is no alternative use or opportunity cost associated with it.

Question 16

One can continue to earn CCA tax shields from an asset sold from an existing pool if:

Accepted Answer

If the Undepreciated Capital Cost (UCC) is positive and greater than the salvage value, then the asset still has tax shield value that can be claimed through the Capital Cost Allowance (CCA) process. This allows for continued tax savings even after the asset has been sold from the existing pool.

Question 17

What is the undiscounted cash flow in the final year of an investment, assuming: 10,000 after-tax cash flows from operations, the fully depreciated machine, the sole asset in the pool, is sold for $1,000, the project had required $2,000 in additional working capital, and a 35 percent tax rate?

Accepted Answer

The calculation of cash flow in the final year of the investment would be:

After-tax cash flows from operations: $10,000 
Proceeds from sale of machine: $1,000 
Release of working capital: $2,000 
Total cash flow: $13,000

Since the tax rate is 35%, the after-tax cash flow in the final year would be:

After-tax cash flow = Total cash flow x (1 - tax rate) 
After-tax cash flow = $13,000 x (1 - 0.35) 
After-tax cash flow = $8,450

Therefore, the answer is option C, $12,650 is incorrect because it does not take into account the tax rate. $14,000 is incorrect because it is not adjusted for taxes, and $12,600 is incorrect because it does not include the tax implications.

Question 18

What nominal annual return is required on an investment in order that an investor experiences a 12 percent gain in purchasing power? Assume inflation to be 4 percent.

Accepted Answer

To achieve a 12% real gain with 4% inflation, the nominal rate is calculated as (1 + 0.12) x (1 + 0.04) - 1 = 0.1648 or 16.48%.

Question 19

The primary difficulty in the allocation of overhead costs to prospective projects is that the:

Accepted Answer

Overhead costs may not represent an incremental expense, meaning that they may not actually increase with the addition of a new project. This can make it difficult to allocate these costs accurately to prospective projects. Additionally, if expenses have already been allocated, it can be challenging to determine how to allocate them further without double-counting. NPV and discount rate are not directly related to the difficulty of allocating overhead costs.

Question 20

The present value at any given discount rate of the depreciation tax shield is:

Accepted Answer

MACRS depreciation results in higher depreciation tax shields than straight-line depreciation, therefore its present value is also higher at any given discount rate. Option A is incorrect as different depreciation methods can result in different depreciation tax shields. Option C is incorrect as the length of the recovery period does not necessarily determine the present value of the depreciation tax shield. Option D is incorrect as inflation does not necessarily increase the present value of the depreciation tax shield.

Quiz 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions