Question 1

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 2

Bath Works Company has $70,000 of depreciation expense and is subject to a 30% income tax rate. On an after-tax basis, depreciation results in a:

Accepted Answer

Depreciation is a non-cash expense, but it provides a tax shield. The tax savings from depreciation is $70,000 * 30% = $21,000, which is an inflow.

Question 3

Hazeldine Company plans to incur $230,000 of additional cash operating expenses and produce $410,000 of additional sales revenue if a capital project is implemented. Assuming a 30% tax rate, these two items collectively should appear in a capital budgeting analysis as:

Accepted Answer

The additional cash operating expenses of $230,000 are considered an outflow, while the additional sales revenue of $410,000 is considered an inflow. However, since there is a 30% tax rate, the net cash flow is calculated as follows:

Net cash flow = (additional sales revenue - additional cash operating expenses) × (1 - tax rate)
Net cash flow = ($410,000 - $230,000) × (1 - 0.30)
Net cash flow = $126,000

Therefore, the additional cash operating expenses and sales revenue should be analyzed together as a $126,000 inflow in the capital budgeting analysis. Choice D is the correct answer.

Question 4

A depreciation tax shield is a(n):

Accepted Answer

A depreciation tax shield is a reduction in income tax.

Question 5

Puck 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 gain on the sale is $5,000 ($18,000 - $13,000). The tax on the gain is $1,500 ($5,000 x 30%). The net cash flow is $18,000 - $1,500 = $16,500.

Question 6

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

Accepted Answer

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

Question 7

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 8

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 9

James 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 loss on disposal is calculated as the difference between the asset's book value (cost - accumulated depreciation) and the selling price. 
Book value = $5,000 - $2,000 = $3,000 
Loss on disposal = $3,000 - $2,500 = $500 
Since the firm is subject to a 30% income tax rate, the tax savings due to the loss would be: 
Tax savings = 30% * $500 = $150 
Therefore, the net cost of the loss on disposal would be: 
Net cost = $500 - $150 = $350

Question 10

Crossword Company is studying a capital project that will produce $600,000 of added sales revenue, $400,000 of additional cash operating expenses, and $50,000 of depreciation. Assuming a 30% income tax rate, the company's after-tax cash inflow (outflow) is:

Accepted Answer

First, we need to calculate the earnings before interest and taxes (EBIT) which is calculated by subtracting the additional cash operating expenses and depreciation from the added sales revenue:

EBIT = $600,000 - $400,000 - $50,000 = $150,000

Next, we need to calculate the taxes owed on the EBIT at a rate of 30%:

Taxes = 0.3 * $150,000 = $45,000

Finally, we can calculate the after-tax cash inflow (outflow) by subtracting the taxes owed from the EBIT:

After-tax cash inflow = EBIT - Taxes = $150,000 - $45,000 = $105,000

Therefore, the correct answer is choice C, $155,000.

Question 11

Braselton Company plans to incur $190,000 of salaries expense and produce $320,000 of additional sales revenue if a capital project is implemented. Assuming a 30% tax rate, these two items collectively should appear in a capital budgeting analysis as:

Accepted Answer

The increase in sales revenue of $320,000 represents a cash inflow. The salaries expense of $190,000 is a cash outflow. The net effect of these two items is a cash inflow of $130,000 before taxes. Adjusting for the 30% tax rate, the after-tax cash inflow is $91,000, which should be included as an inflow in the capital budgeting analysis.

Question 12

James 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 James Company has an asset that cost...

Question 13

Raymon Company received $7,000 cash from the sale of a machine that had an $11,000 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 answer of Raymon Company received $7,000 cash from the...

Question 14

Preston Company is considering the use of accelerated depreciation rather than straight-line depreciation for a new asset acquisition. Which of the following choices correctly shows when the majority of depreciation would be taken (early or late in the asset's life), when most of the tax savings occur (early or late in the asset's life), and which depreciation method would have the higher present value?

Accepted Answer

The answer of Preston Company is considering the use of...

Question 15

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 16

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

Statement I is correct because a depreciation tax shield reduces a company's taxable income and therefore reduces its tax liability. 
Statement II is incorrect because a depreciation tax shield should be considered when doing a net-present-value analysis because it affects cash flows. 
Statement III is correct because a depreciation tax shield can occur over the useful life of an asset, which could be longer than one year. Therefore, both statements I and III are correct.

Question 17

Ruiz 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 Ruiz Company purchased equipment for $30,000 in...

Question 18

A company that uses accelerated depreciation:

Accepted Answer

A company using accelerated depreciation would write off a larger portion of an asset's cost sooner than under the straight-line method. This means that in the early years of owning the asset, the company would be able to reduce its taxable income by a larger amount. Therefore, more tax benefits occur earlier than under the straight-line method.

Question 19

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 a method of accelerated depreciation that allows businesses to write off the cost of assets more rapidly. MACRS is the preferred method of depreciation for income tax purposes in the United States.

Question 20

Wrangler 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. Wrangler should include a $100,000 outflow that occurs at time 0 in a discounted-cash-flow analysis.
II. Wrangler should include separate $100,000 outflows in each year of the project's five-year life.
III. Wrangler 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

Statement I is correct because the initial outflow of working capital must be included in the cash flow analysis. 
Statement II is incorrect because the $100,000 outflow occurs only at the beginning and not annually. 
Statement III is correct because the company recovers the $100,000 investment in working capital at the end of the project's life. Thus, the correct statements are I and III.

Quiz 16: Capital Expenditure Decisions

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: