Question 1

The law firm of Bushmaster, Cobra, and Asp is considering investing in a complete small business computer system. The initial investment will be $50,000. The computer is in the 5-year MACRS category, and the firm's tax rate is 34%. The computer system is expected to provide additional revenue of $32,000 per year for the next six years, and to reduce expenses by $7,000 per year for the same period.
a) Calculate the net after-tax cash flows from this investment.
b) Calculate the net present value of the system, given that the law firm's weighted average cost of capital is 12%.
c) Should they buy the computer system?

Accepted Answer

The answer of The law firm of Bushmaster, Cobra, and...

Question 2

A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is raised, the net cash outflow (purchase price less proceeds from the sale of the old asset) would

Accepted Answer

If the asset is selling below book value, a

Question 3

A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the following two projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 12% cost of capital, which decision should the financial manager make?

Accepted Answer

The answer of A firm utilizes a strategy of capital...

Question 4

Technology Corp. is considering a $200,000 investment in a new marketing campaign that they anticipate will provide annual cash flows of $52,000 for the next five years. The firm has a 10% cost of capital. What should the analysis indicate to the firm's managers?

Accepted Answer

The answer of Technology Corp. is considering a $200,000 investment...

Question 5

A&B Enterprises is trying to select the best investment from among four alternatives. Each alternative involves an initial outlay of $100,000. Their cash flows follow: $\begin{array}{crrrrr}
\text { Year } & {\mathrm{A}} & {\mathrm{B}} & \mathrm{C} & {\mathrm{D}} \
1 & \$ 10,000 & \$ 50,000 & \$ 25,000 & \$  0 \
2 & 20,000 & 40,000 & 25,000 & \$ 0 \
3 & 30,000 & 30,000 & 25,000 & 45,000 \
4 & 40,000 & 0 & 25,000 & 55,000 \
5 & 50,000 & 0 & 25,000 &  60,000
\end{array}$ Evaluate and rank each alternative based on a) payback period, b) net present value (use a 10% discount rate), and c) internal rate of return. For the internal rate of return, please use Excel's "IRR" function as described in the text.

Accepted Answer

The answer of A&B Enterprises is trying to select the...

Question 6

The Taylor Corporation is using a machine that originally cost $88,000. The machine is being depreciated by the straight-line method over eight years ($11,000 per year) and has four years of depreciation remaining. The machine has a book value of $44,000 and a current market value of $40,000. Jacqueline Elliott, the Chief Financial Officer of Taylor, is considering replacing this machine with a newer model costing $75,000. The new machine will save $5,000 in after-tax earnings each year for the next six years. The new machine is in the 5-year MACRS category. Taylor Corporation is in the 34% tax bracket and has a 10% cost of capital.
a) Calculate the cash inflows from the sale of the old machine.
b) Calculate the net cost of the new machine.
c) Calculate the incremental depreciation on the new versus the old machine.
d) Determine the net present value of the new machine. Should they purchase the new machine?

Accepted Answer

The answer of The Taylor Corporation is using a machine...

Question 7

Tabletop Ranches Inc. is considering the purchase of a new helicopter for $400,000. The firm's old helicopter has a book value of $90,000, but can only be sold for $60,000. It was being depreciated at the rate of $13,500 per year for four more years under an old depreciation method.
The new helicopter will be depreciated using the 5-year MACRS schedule. It is expected to save $75,000 after taxes through reduced fuel and maintenance expenses. Tabletop Ranch is in the 34% tax bracket and has a 12% cost of capital. Assume a six-year time horizon.
a) Calculate the cash inflows from selling the old helicopter.
b) Calculate the net cost of the new helicopter.
c) Calculate the incremental depreciation for the new helicopter.
d) Calculate the net cash flows for the purchase.
e) Calculate the net present value of the helicopter purchase and state whether or not the firm should buy it.

Accepted Answer

The answer of Tabletop Ranches Inc. is considering the purchase...

Question 8

Project X has a cost of $100,000 and provides the following annual earnings: year 1 $35,000; year 2 $25,000; year 3 $175,000; and year 4 $10,000. Under the payback method, in which year is the investment recouped?

Accepted Answer

$100,000 out, less year 1 (35,000), year 2 (25,000), and year 3 (175,000) means the payback point must have been reached in the third year of cash inflows.

Question 9

All of the following is information required to create a net present value profile except for which one?

Accepted Answer

The net present value profile requires NPV calculations at different discount rates, including the cost of capital and the IRR of the investment. However, the NPV at the risk-free rate is not necessary to create the profile.

Question 10

In a replacement decision, if an old asset sells below book value, from a tax standpoint

Accepted Answer

When an old asset sells below book value, it results in a tax-deductible loss, which reduces taxable income and thus increases cash flow due to the tax savings.

Question 11

Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000. The current market value of the old machine is $18,000 but the book value is $32,000. The firm's tax rate for ordinary income is 30%. What is the net cash outflow for the new machine after considering the sale of the old machine? Disregard the effect of depreciation of the new machine if acquired.

Accepted Answer

To determine the net cash outflow, we need to consider the cash inflow from the sale of the old machine and the cash outflow for the new machine after taxes.

Cash inflow from sale of old machine:

Market value = $18,000 
Book value = $32,000

Because the market value is less than the book value, selling the machine would result in a loss. The tax effect of this loss can be calculated as follows:

Loss on sale = $18,000 - $32,000 = $-14,000 
Tax savings = $-14,000 x 0.3 = $-4,200

The tax savings will reduce the cash outflow required for the new machine.

Cash outflow for new machine:

Purchase price = $70,000 
Tax savings from loss on sale = $4,200 
Net cash outflow = $70,000 - $4,200 = $65,800

Therefore, the net cash outflow for the new machine after considering the sale of the old machine is:

Net cash outflow = $65,800 - $18,000 = $47,800

The correct answer is A.

Quiz 12: The Capital Budgeting Decision

A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is raised, the net cash outflow (purchase price less proceeds from the sale of the old asset) would

Technology Corp. is considering a $200,000 investment in a new marketing campaign that they anticipate will provide annual cash flows of $52,000 for the next five years. The firm has a 10% cost of capital. What should the analysis indicate to the firm's managers?

Project X has a cost of $100,000 and provides the following annual earnings: year 1 $35,000; year 2 $25,000; year 3 $175,000; and year 4 $10,000. Under the payback method, in which year is the investment recouped?

All of the following is information required to create a net present value profile except for which one?

In a replacement decision, if an old asset sells below book value, from a tax standpoint