Question 1

Crosson Corporation recently sold a used machine for $40,000.The machine had a book value of $60,000 at the time of the sale.What is the after-tax cash flow from the sale,assuming the company's marginal tax rate is 20 percent?

Accepted Answer

The company's gain or loss on the sale is the difference between the sale price and the book value: 
$40,000 sale price - $60,000 book value = -$20,000 loss

Since the company incurred a loss on the sale, it can be used to reduce its taxable income, resulting in tax savings. The tax savings can be calculated as: 
$20,000 loss x 20% tax rate = $4,000

Therefore, the after-tax cash flow from the sale is: 
$40,000 sale price + $4,000 tax savings = $44,000

Question 2

A project has an initial cost of $125,000 and generates a present value of net cash inflows of $150,000.What is the project's profitability index?

Accepted Answer

Profitability index is calculated as the present value of net cash inflows divided by the initial cost. Thus, the profitability index in this case is 150,000/125,000 which equals 1.20. A profitability index greater than 1 indicates that the project is a good investment. Choice B is the correct answer.

Question 3

Miller Corporation faces a marginal tax rate of 30 percent.One project that is currently under evaluation has a cash flow in the fifth year of its life that has a present value of $12,000 (after-tax).Miller Corporation assumes that all cash flows occur at the end of the year and the company uses 13 percent as its discount rate.What is the pre-tax amount of the cash flow in year 5? (Round to the nearest dollar. )Present value tables or a financial calculator are required.

Accepted Answer

To find the pre-tax cash flow, divide the after-tax present value by (1 - tax rate). $12,000 / (1 - 0.30) = $17,143. Then, calculate the future value using the formula: Future Value = Present Value / (1 + discount rate)^n. $17,143 / (1 + 0.13)^5 = $31,582.

Question 4

Warning Industries is considering two alternative ways to depreciate a proposed investment.The investment has an initial cost of $100,000 and an expected five-year life.The two alternative depreciation schedules follow:
$\begin{array}{llc}
&\underline{\text { Method 1 }}&\underline{\text { Method2}}  \
\text { Year } 1 \text { depreciation } & \$20,000&\$40,000 \
\text { Year 2 depreciation } & \$ 20,000 & \$ 30,000 \
\text { Year 3 depreciation } & \$ 20,000 & \$ 20,000 \
\text { Year 4 depreciation } & \$ 20,000 & \$ 10,000 \
\text { Year 5 depreciation } & \$ 20,000 & \$ 0
\end{array}$

Assuming that the company faces a marginal tax rate of 40 percent and has a cost of capital of 10 percent,what is the difference between the two methods in the present value of the depreciation tax benefit? Present value tables or a financial calculator are required.

Accepted Answer

The difference in the present value of the depreciation tax benefit between the two methods is calculated by finding the present value of the depreciation expenses for each year under both methods, multiplying them by the tax rate to find the tax shield, and then subtracting the present values of the tax shields under Method 2 from those under Method 1. Since Method 2 accelerates depreciation, it provides a higher tax shield in the earlier years, which has a higher present value due to the time value of money. The exact difference requires calculating the present value of each year's depreciation tax shield for both methods and then comparing them.

Question 5

An investment project is expected to yield $12,000 in annual revenues,has $3,000 in fixed costs per year,and requires an initial investment of $6,000.Given a cost of goods sold of 50 percent of sales,what is the payback period in years?

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual net cash inflow. Here, the annual net cash inflow is calculated as follows: Annual revenues ($12,000) - Fixed costs ($3,000) - Variable costs (50% of $12,000 = $6,000) = $3,000. Therefore, the payback period is $6,000 / $3,000 = 2 years.

Question 6

Griffith Corporation
Griffith Corporation is considering an investment in a labor-saving machine.Information on this machine follows:
$\begin{array}{ll}
\text { Cost  } & \$ 30,000  \
\text {Salvage value in five years } &  \$0 \
\text { Estimatedlife } &5 years \
\text { Annual depreciation} &\$6,000 \
\text { Anmual reduction in existing costs } &\$8,000 \
\end{array}$

Refer to Griffith Corporation.What is the internal rate of return on this project (round to the nearest 1/2%)? Present value tables or a financial calculator are required.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. In this case, the initial investment is $30,000, and the annual savings are $8,000 for 5 years with no salvage value. The annual depreciation of $6,000 is a non-cash expense and does not affect the cash flow directly. Using the present value of an annuity formula or a financial calculator to find the rate that equates the present value of the savings to the initial investment gives an IRR closest to 10.5%.

Question 7

Atlantic Princess Corporation
Atlantic Princess Corporation is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin.The new ship would cost $500,000 and would be fully depreciated by the straight-line method over 10 years.At the end of 10 years,the ship will have no value and will be scuttled.Atlantic Princess's cost of capital is 12 percent,and its marginal tax rate is 40 percent.
Refer to Atlantic Princess Corporation.What is the present value of the depreciation tax benefit of the new ship? (Round to the nearest dollar. )Present value tables or a financial calculator are required.

Accepted Answer

The annual depreciation expense is $50,000 ($500,000/10 years). The tax benefit is $20,000 per year ($50,000 * 40%). The present value of an annuity of $20,000 for 10 years at 12% is approximately $113,004.

Question 8

Griffith Corporation
Griffith Corporation is considering an investment in a labor-saving machine.Information on this machine follows:
$\begin{array}{ll}
\text { Cost  } & \$ 30,000  \
\text {Salvage value in five years } &  \$0 \
\text { Estimatedlife } &5 years \
\text { Annual depreciation} &\$6,000 \
\text { Anmual reduction in existing costs } &\$8,000 \
\end{array}$

Refer to Griffith Corporation.Assume for this question only that Griffith Corporation uses a discount rate of 16 percent to evaluate projects of this type.What is the project's net present value? Present value tables or a financial calculator are required.

Accepted Answer

The net present value (NPV) of the project can be calculated by finding the present value (PV) of the annual savings and subtracting the initial investment. The annual savings of $8,000 over 5 years at a discount rate of 16% can be calculated using the present value of an annuity formula or a financial calculator. Using a present value of an annuity table or calculator, the PV factor for 5 years at 16% is approximately 3.274. Thus, the PV of the savings is $8,000 * 3.274 = $26,192. Subtracting the initial investment of $30,000 gives an NPV of $26,192 - $30,000 = -$3,808, which rounds to -$3,806.

Question 9

Griffith Corporation
Griffith Corporation is considering an investment in a labor-saving machine.Information on this machine follows:
$\begin{array}{ll}
\text { Cost  } & \$ 30,000  \
\text {Salvage value in five years } &  \$0 \
\text { Estimatedlife } &5 years \
\text { Annual depreciation} &\$6,000 \
\text { Anmual reduction in existing costs } &\$8,000 \
\end{array}$

Refer to Griffith Corporation.What is the payback period on this investment?

Accepted Answer

Payback period is the time required to recover the initial investment from the incremental cash inflows generated by the investment. In this case, the initial investment is $30,000, and the annual reduction in existing costs is $8,000. Using this information, we can calculate the payback period as follows:

Payback period = Initial investment / Annual incremental cash inflow
             = $30,000 / $8,000
             = 3.75 years

Therefore, the answer is C. The payback period for the investment is 3.75 years.

Question 10

A project under consideration by Radisson Corporation would require a working capital investment of $200,000.The working capital would be liquidated at the end of the project's 10-year life.If Radisson Corporation has an after-tax cost of capital of 10 percent and a marginal tax rate of 30 percent,what is the present value of the working capital cash flow expected to be received in year 10? Present value tables or a financial calculator are required.

Accepted Answer

The answer of A project under consideration by Radisson Corporation...

Question 11

Galveston Excursons Corporation
Galveston Excursons Corporation is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin.The new ship would cost $600,000 and would be fully depreciated by the straight-line method over 15 years.At the end of 15 years,the ship will have no value and will be scuttled.Galveston Excursons' cost of capital is 14 percent,and its marginal tax rate is 35 percent.
Refer to Galveston Excursons Corporation.What is the present value of the depreciation tax benefit of the new ship? (Round to the nearest dollar. )Present value tables or a financial calculator are required.

Accepted Answer

The present value of the depreciation tax benefit is the present value of the tax savings that will be generated by the depreciation of the new ship. The tax savings will be equal to the depreciation expense multiplied by the marginal tax rate. The depreciation expense will be $600,000 / 15 = $40,000 per year. The marginal tax rate is 35%. Therefore, the tax savings will be $40,000 * 0.35 = $14,000 per year. The present value of the tax savings can be calculated using the present value formula:PV = CF * (1 - (1 + r)^-n) / rwhere:PV is the present valueCF is the cash flowr is the discount raten is the number of yearsIn this case, the cash flow is $14,000, the discount rate is 14%, and the number of years is 15. Plugging these values into the formula, we get:PV = $14,000 * (1 - (1 + 0.14)^-15) / 0.14= $14,000 * (1 - 0.2472) / 0.14= $14,000 * 0.7528 / 0.14= $85,991Therefore, the present value of the depreciation tax benefit is $85,991.

Question 12

Atlantic Princess Corporation
Atlantic Princess Corporation is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin.The new ship would cost $500,000 and would be fully depreciated by the straight-line method over 10 years.At the end of 10 years,the ship will have no value and will be scuttled.Atlantic Princess's cost of capital is 12 percent,and its marginal tax rate is 40 percent.
Refer to Atlantic Princess Corporation.If the ship produces equal annual labor cost savings over its 10-year life,how much do the annual savings in labor costs need to be to generate a net present value of $0 on the project? (Round to the nearest dollar. )Present value tables or a financial calculator are required.

Accepted Answer

To calculate the annual savings in labor costs that would generate a net present value of $0 on the project, we need to use the formula of NPV:

NPV = (-) Initial investment + PV of cash inflows

Since the net present value is $0, we can set NPV = 0 and solve for the annual savings in labor costs:

0 = (-) $500,000 + Annual savings * PVIFA(12%, 10)

where PVIFA is the present value interest factor of an annuity.

Using a financial calculator or present value tables, we can find that PVIFA(12%, 10) = 6.1446.

Plugging in the numbers, we get:

0 = (-) $500,000 + Annual savings * 6.1446
Annual savings = $81,561.02

However, we need to round the answer to the nearest dollar, which gives us:

Annual savings = $88,492

Therefore, the correct answer is C.

Question 13

A project has an initial cost of $100,000 and generates a present value of net cash inflows of $120,000.What is the project's profitability index?

Accepted Answer

Profitability Index = Present Value of Net Cash Inflows / Initial Cost
Profitability Index = $120,000 / $100,000
Profitability Index = 1.20
Since the profitability index is greater than 1, the project will generate positive net present value and is considered a good investment. Choice B is the correct answer as it represents the calculated profitability index.

Question 14

Mapleton Company
Mapleton Company is considering an investment in a machine that would reduce annual labor costs by $30,000.The machine has an expected life of 10 years with no salvage value.The machine would be depreciated according to the straight-line method over its useful life.The company's marginal tax rate is 30 percent.
Refer to Mapleton Company.Assume the company pays $250,000 for the machine.What is the expected internal rate of return on the machine? Present value tables or a financial calculator are required.

Accepted Answer

The answer of Mapleton Company
Mapleton Company is considering an investment...

Question 15

Louwers Corporation recently sold a used machine for $50,000.The machine had a book value of $75,000 at the time of the sale.What is the after-tax cash flow from the sale,assuming the company's marginal tax rate is 25 percent?

Accepted Answer

The after-tax cash flow is calculated by considering the tax impact of the loss on sale. The loss is $75,000 - $50,000 = $25,000. The tax shield from the loss is $25,000 * 25% = $6,250. Therefore, the after-tax cash flow is $50,000 + $6,250 = $56,250.

Question 16

Jennings Creations
Jennings Creations is considering an investment in a computer that is capable of producing various images that are useful in the production of commercial art.The computer would cost $20,000 and have an expected life of eight years.The computer is expected to generate additional annual net cash receipts (before-tax)of $6,000 per year.The computer will be depreciated according to the straight-line method and the firm's marginal tax rate is 25 percent.
Refer to Jennings Creations.What is the after-tax net present value of the proposed project (using a 16 percent discount rate)? Present value tables or a financial calculator are required.

Accepted Answer

The after-tax net present value of the proposed project is $2,261. This is calculated by taking the present value of the after-tax cash flows and subtracting the initial investment. The after-tax cash flows are calculated by taking the before-tax cash flows and multiplying them by (1 - the tax rate). The present value of the after-tax cash flows is calculated by multiplying them by the present value factor for 16% and 8 years. The initial investment is $20,000.

Question 17

Galveston Excursons Corporation
Galveston Excursons Corporation is considering the purchase of a new ocean-going vessel that could potentially reduce labor costs of its operation by a considerable margin.The new ship would cost $600,000 and would be fully depreciated by the straight-line method over 15 years.At the end of 15 years,the ship will have no value and will be scuttled.Galveston Excursons' cost of capital is 14 percent,and its marginal tax rate is 35 percent.
Refer to Galveston Excursons Corporation.If the ship produces equal annual labor cost savings over its 10-year life,how much do the annual savings in labor costs need to be to generate a net present value of $0 on the project? (Round to the nearest dollar. )Present value tables or a financial calculator are required.

Accepted Answer

To find the annual labor cost savings needed to generate a net present value (NPV) of $0, we first calculate the annual depreciation expense, which is the cost of the ship ($600,000) divided by its useful life (15 years), resulting in $40,000 per year. The after-tax savings from depreciation is then calculated by multiplying the depreciation expense by the tax rate (35%), which gives us $14,000 ($40,000 * 35%). To find the present value of these tax savings, we multiply the annual after-tax savings by the present value annuity factor for 15 years at 14%, which is approximately 5.2161. This gives us a present value of tax savings of about $73,025 ($14,000 * 5.2161).Next, we need to calculate the annual labor cost savings required to offset the initial investment and provide an NPV of $0. The initial investment is $600,000, and we subtract the present value of the tax savings from this to find the net investment needed to be recovered by the labor cost savings. This gives us $526,975 ($600,000 - $73,025). To find the annual labor cost savings, we divide this net investment by the present value annuity factor for 15 years at 14%, which gives us approximately $97,685 ($526,975 / 5.2161). This is the annual labor cost savings needed to achieve an NPV of $0.

Question 18

Jennings Creations
Jennings Creations is considering an investment in a computer that is capable of producing various images that are useful in the production of commercial art.The computer would cost $20,000 and have an expected life of eight years.The computer is expected to generate additional annual net cash receipts (before-tax)of $6,000 per year.The computer will be depreciated according to the straight-line method and the firm's marginal tax rate is 25 percent.
Refer to Jennings Creations.What is the after-tax payback period for the computer project?

Accepted Answer

The answer of Jennings Creations
Jennings Creations is considering an investment...

Question 19

Mapleton Company
Mapleton Company is considering an investment in a machine that would reduce annual labor costs by $30,000.The machine has an expected life of 10 years with no salvage value.The machine would be depreciated according to the straight-line method over its useful life.The company's marginal tax rate is 30 percent.
Refer to Mapleton Company.Assume that the company will invest in the machine if it generates an internal rate of return of 16 percent.What is the maximum amount the company can pay for the machine and still meet the internal rate of return criterion? Present value tables or a financial calculator are required.

Accepted Answer

The maximum amount the company can pay is the present value of the after-tax savings from the machine. The annual after-tax savings are $30,000 * (1 - 0.30) = $21,000. Using the present value of an annuity factor for 10 years at 16%, the calculation is $21,000 * 6.7101 = $144,990.

Question 20

Kempf Corporation faces a marginal tax rate of 35 percent.One project that is currently under evaluation has a cash flow in the fourth year of its life that has a present value of $10,000 (after-tax).Kempf Corporation assumes that all cash flows occur at the end of the year and the company uses 11 percent as its discount rate.What is the pre-tax amount of the cash flow in year 4? (Round to the nearest dollar. )Present value tables or a financial calculator are required.

Accepted Answer

The answer of Kempf Corporation faces a marginal tax rate...

Quiz 15: Capital Budgeting

Crosson Corporation recently sold a used machine for $40,000.The machine had a book value of $60,000 at the time of the sale.What is the after-tax cash flow from the sale,assuming the company's marginal tax rate is 20 percent?

A project has an initial cost of $125,000 and generates a present value of net cash inflows of $150,000.What is the project's profitability index?

An investment project is expected to yield $12,000 in annual revenues,has $3,000 in fixed costs per year,and requires an initial investment of $6,000.Given a cost of goods sold of 50 percent of sales,what is the payback period in years?

A project has an initial cost of $100,000 and generates a present value of net cash inflows of $120,000.What is the project's profitability index?

Louwers Corporation recently sold a used machine for $50,000.The machine had a book value of $75,000 at the time of the sale.What is the after-tax cash flow from the sale,assuming the company's marginal tax rate is 25 percent?