Question 1

Your firm needs a machine which costs $50,000, and requires $2,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 35 percent and a discount rate of 10 percent. What is the depreciation tax shield for this project in year 3?

Accepted Answer

The MACRS three-year class life percentages are 33.33%, 44.45%, 14.81%, and 7.41%. In year 3, the depreciation is 14.81% of $50,000, which is $7,405. The tax shield is the depreciation amount multiplied by the tax rate: $7,405 * 0.35 = $2,591.75.

Question 2

A manufacturing firm is planning on expanding its existing operations. The expansion project is significant and will require the firm to house the expansion in a different location. The firm is considering building on a lot they own across town. The lot is currently vacant and it was paid for nearly 20 years ago. Given this information, which of the following statements is correct?

Accepted Answer

The lot is an incremental cash flow because it represents an opportunity cost. The firm could potentially sell the lot and receive cash inflows instead of using it for the expansion project, which is a significant cost to the firm. Therefore, the value of the lot represents an opportunity cost and should be considered as an incremental cash flow in the decision-making process.

Question 3

The research chemists at MegaClean created a new cleaner that keeps car and truck tires shiny and clean for one year. They believe that this product will be highly successful and will attract customers to purchase their existing line of household cleaning products. This is an example of:

Accepted Answer

The introduction of the new tire cleaner is expected to complement the existing line of household cleaning products as it is likely to attract customers to purchase both products. The substitutionary effect refers to a situation where the introduction of a new product may replace an existing product, which is not the case here. The opportunity effect refers to the potential benefit from an unexpected scenario, which is not applicable here. Sunk cost refers to a cost that has already been incurred and cannot be recovered, which is also not relevant to this situation.

Question 4

Your firm needs a machine which costs $500,000, and requires $15,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 35 percent and a discount rate of 10 percent. If this machine can be sold for $50,000 at the end of year 3, what is the after-tax salvage value?

Accepted Answer

The answer of Your firm needs a machine which costs...

Question 5

You are evaluating a project for your company. You estimate the sales price to be $40 per unit and sales volume to be 2,000 units in year 1; 8,000 units in year 2; and 4,000 units in year 3. The project has a three-year life. Variable costs amount to $25 per unit and fixed costs are $20,000 per year. The project requires an initial investment of $16,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $1,000. NWC requirements at the beginning of each year will be approximately 25 percent of the projected sales during the coming year. The tax rate is 35 percent and the required return on the project is 10 percent. What change in NWC occurs at the end of year 1?

Accepted Answer

The answer of You are evaluating a project for your...

Question 6

A local bank is contemplating opening a new branch bank in a large superstore across town from their main office. It is estimated that the new branch will generate $20,000 after expenses each month. The manager wonders if all these revenues should be considered an incremental cash flow. Given this information, which of the following statements is correct?

Accepted Answer

It is likely that some amount less than the $20,000 is incremental because the new branch may attract customers who previously used other branches of the bank, thereby reducing revenue at those branches. This is known as substitutionary effect. Therefore, it is necessary to assess the potential loss of revenue from existing branches to determine the true incremental cash flow of the new branch. Option A is incorrect because some of the revenues generated by the new branch may not be incremental. Option B is a valid point but not directly related to the question. Option D is incorrect because complementary effects imply that the new branch would increase revenue at existing branches.

Question 7

An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the: ___________________.

Accepted Answer

The cost of an asset plus any additional expenses incurred to make the asset ready for use, such as sales tax, freight charges, and installation and testing fees, is referred to as the depreciable basis. This is important because it determines the amount of depreciation that can be taken on the asset over its useful life. The other options, opportunity cost and sunk cost, do not apply in this context. The phrase "asset costing reference" does not have a commonly recognized meaning in accounting.

Question 8

A new project would require an immediate increase in raw materials in the amount of $1,000. The firm expects that accounts payable will automatically increase $800. How much must the firm expect its investment in net working capital to change if they accept this project?

Accepted Answer

The increase in raw materials is $1,000, and accounts payable will increase by $800. Therefore, the net change in working capital will be $1,000 - $800 = $200. Option B is the correct choice.

Question 9

AB Mining Company just commissioned a firm to identify if an unused portion of their mine contains any silver or gold at a cost of $125,000. This is an example of a(n):

Accepted Answer

The $125,000 spent on the firm to identify if there is any silver or gold in the unused portion of the mine is a sunk cost because it is a cost that has already been incurred and cannot be recovered, regardless of future outcomes.

Question 10

Coke is planning on marketing a new drink called Very Berry Coke which is a mixture of raspberry and blackberry flavors blended to perfection and added to the highly secret Coca-Cola formula. This new product is expected to reduce the sales of their existing product, Cherry Coke, by $10 million per year. This is an example of a:

Accepted Answer

The introduction of Very Berry Coke, which is a similar but different product compared to Cherry Coke, is expected to reduce the sales of Cherry Coke by $10 million per year. This is an example of the substitutionary effect, where the introduction of a new product reduces the sales of an existing product as both products are viewed as substitutes by consumers.

Question 11

Equipment was purchased for $250,000 plus $500 in freight charges. Installation costs were $750 and sales tax totaled $18,750. Hiring a special consultant to provide advice during the selection of the equipment cost $500. What is this asset's depreciable basis?

Accepted Answer

The depreciable basis is the total cost of the asset, which includes the purchase price, freight charges, installation costs, and sales tax, but excludes any costs for consultants. Therefore, the depreciable basis is: 
$250,000 + $500 + $750 + $18,750 = $269,000. 
The cost for the special consultant is not included in the depreciable basis.

Question 12

The process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements is referred to as:

Accepted Answer

The process described is known as pro forma analysis, which involves forecasting future cash flows based on the relevant financial information. Option A is unrelated to the concept described. Option C refers to the incremental impact of a specific project on a company's overall cash flows, but does not relate to the specific process of estimating future cash flows. Option D includes depreciation analysis, which may be a component of pro forma analysis but is not the primary focus of the process described.

Question 13

A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications that has a monthly cost of $50 per month. This is an example of:

Accepted Answer

This cost is an incremental cash flow because it is a cost that will be incurred as a result of adding the new ATM.

Question 14

Suppose you sell a fixed asset for $10,000 when its book value is $2,000. If your company's marginal tax rate is 35 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?

Accepted Answer

The after-tax cash flow of this sale is $7,200. This is calculated as follows:Sale price: $10,000Book value: $2,000Gain on sale: $8,000Taxes on gain: $8,000 x 35% = $2,800After-tax cash flow: $10,000 - $2,800 = $7,200

Question 15

Equipment was purchased for $100,000 plus $1,000 in freight charges. Installation costs were $500 and sales tax totaled $7,500. Hiring a special consultant to provide advice during the selection of the equipment cost $1,000. What is this asset's depreciable basis?

Accepted Answer

The answer of Equipment was purchased for $100,000 plus $1,000...

Question 16

A new project would require an immediate increase in raw materials in the amount $6,000. The firm expects that accounts payable will automatically increase $2,000. How much must the firm expect its investment in net working capital to increase if they accept this project?

Accepted Answer

The increase in net working capital is calculated as the increase in raw materials ($6,000) minus the increase in accounts payable ($2,000), resulting in a net increase of $4,000.

Question 17

You are evaluating a project for your company. You estimate the sales price to be $100 per unit and sales volume to be 5,000 units in year 1; 10,000 units in year 2; and 2,500 units in year 3. The project has a three-year life. Variable costs amount to $50 per unit and fixed costs are $75,000 per year. The project requires an initial investment of $250,000 in assets that will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $25,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 35 percent and the required return on the project is 14 percent. What change in NWC occurs at the end of year 1?

Accepted Answer

The answer of You are evaluating a project for your...

Question 18

Your firm needs a machine which costs $50,000, and requires $2,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 35 percent and a discount rate of 10 percent. If this machine can be sold for $3,000 at the end of year 5, what is the after-tax salvage value?

Accepted Answer

The after-tax salvage value is the salvage value multiplied by (1 - tax rate). In this case, the salvage value is $3,000, the tax rate is 35%, and the after-tax salvage value is $3,000 * (1 - 0.35) = $1,950.

Question 19

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a(n):

Accepted Answer

A sunk cost is a cost that has already been incurred and cannot be recovered. It is irrelevant to future decision making since it cannot be changed or avoided.

Question 20

Your firm needs a machine which costs $20,000, and requires $1,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life category. Assume a tax rate of 40 percent and a discount rate of 9 percent. What is the depreciation tax shield for this project in year 3?

Accepted Answer

The MACRS three-year class life category means that the depreciation will be deducted for 33.33% in year 1, 44.45% in year 2, 14.81% in year 3, and 7.41% in year 4 (note that the fourth year is included for the purpose of the calculation, even though there will be no machine in that year).

So, in year 3, the depreciation deduction will be $20,000 x 14.81% = $2,962.

The depreciation tax shield is the tax savings due to the depreciation deduction, which is calculated as the depreciation deduction multiplied by the tax rate.

Therefore, the depreciation tax shield in year 3 is $2,962 x 40% = $1,184.80.

Option A is the correct choice.

Quiz 12: Estimating Cash Flows on Capital Budgeting Projects