Deck 9: Making Capital Investment Decisions

Question 1

Alfonso and Sons purchased a new grinding machine two years ago at a cost of
$390 000.Last year,some revolutionary developments occurred making their machine virtually worthless as it cannot produce products which meet the higher quality standards of the newer machines.If Alfonso and Sons continue using their current machine they will lose all their customers.They have not found anyone willing to purchase the machine even at a deeply discounted price.The best description of this machine today is that it is a(n)_____ cost.

A)erosion
B)rationed
C)sunk
D)market
E)opportunity

Answer 1

sunk

Question 2

A debt-free firm has net income of $128 400,taxes of $46 200,and depreciation of $21 300.What is the operating cash flow?

A)$82 200
B)$103 500
C)$107 100
D)$149 700
E)$195 900

Answer 2

$149 700

Question 3

Shere Khan Corporation is currently evaluating a new project.Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased,but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs.Further,the company's inventories would have to be increased by $20 000 at the time of initial investment.The straight-line depreciation rate is 20% and corporate tax rate is 25%.Calculate the tax effect of depreciation on annual cash flows.

A)$15 000
B)$11 250
C)$18 000
D)$18 750
E)$17 000

Answer 3

$17 000

Question 4

A cost that has already been incurred and cannot be recouped is referred to as a(n)_____ cost.

A)sunk
B)relevant
C)opportunity
D)financial
E)side

Question 5

Kate's Store is considering three mutually exclusive options for the use of the new addition to her facility.Kate can either expand the women's clothing section,add a new footwear section,or expand into home linens.She estimates annual profits of either $120 000 from the clothing,$104 000 from the footwear,or $98 000 from the home linens section,should that section be chosen for the expansion.What is the opportunity cost of her most profitable option?

A)$98 000
B)$104 000
C)$120 000
D)$202 000
E)$224 000

Question 6

Which one of the following can be completely ignored when analysing a project?

A)depreciation
B)taxes
C)net working capital
D)sunk cost
E)erosion

Question 7

The analysis of the effect that a single variable has on the net present value of a project is called ________ analysis

A)sensitivity
B)erosion
C)cost reduction
D)scenario
E)benefit

Question 8

An opportunity cost is defined as:

A)the increased cost incurred when a new project is accepted
B)the increased sales of an existing product if a new product is added to a firm's offerings
C)a cost that has been incurred and cannot be recouped
D)the potential lost sales that are forfeited when a project is rejected
E)the most valuable alternative that is given up if a particular investment is undertaken

Question 9

Jeans 'n' More currently sells blue jeans and T-shirts.Management is considering adding fleece tops to their range to provide a cooler weather option.The tops would sell for $39 each and they expect to sell 6000 per year.By adding the fleece tops,management feels that they will sell an additional 1200 pairs of jeans at $45 a pair and 500 fewer T-shirts at $10 each.The variable cost per unit is $20 on the jeans,$4.50 on the T-shirts,and $22 on the fleece tops.The incremental annual depreciation expense related to the fleece top is $32 000 and the incremental annual fixed costs related to the fleece top are $60 000.The tax rate is 35 per cent.What is the project's operating cash flow?

A)$45 012.50
B)$54 612.50
C)$56 212.50
D)$62 212.50
E)$65 812.50

Question 10

Ignoring the option to expand:

A)overestimates the internal rate of return on a project
B)underestimates the net present value of a project
C)ignores the possibility that a negative net present value project might be positive given changes over time
D)ignores the possibility that one variable is the primary source of the forecasting risk associated with a project
E)ignores the value of discontinuing a project early

Question 11

A proposed project will reduce the amount of inventory a firm must keep on hand.This effect:

A)should be ignored when analysing the viability of the project
B)is a cash outflow relevant to the first year of the project
C)is an initial cash inflow that should be included in the analysis
D)is a negative capital expenditure at time zero
E)is an erosion cost and should be included in the annual net income of the project

Question 12

The incremental cash flows of a project can best be defined as the difference between a firm's _____ with and without the project.

A)net worth
B)net income
C)present cash flows
D)future cash flows
E)operating cash flow

Question 13

Shere Khan Corporation is currently evaluating a new project.Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased,but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs.Further,the company's inventories would have to be increased by $20 000 at the time of initial investment.The straight-line depreciation rate is 20% and corporate tax rate is 25%.
Calculate the annual depreciation.

A)$60 000
B)$45 000
C)$72 000
D)$75 000
E)$68 000

Question 14

Lauer's have decided to expand their retail shop by building on a vacant lot they own.The company will build a new building at an estimated cost of $1.8 million.The firm will spend another $400 000 on the parking and access roads.The land was purchased ten years ago at a cost of $900 000.Today,that land is worth $2.8 million.What is the cost of this expansion project?

A)$2.2 million
B)$3.1 million
C)$4.6 million
D)$5.0 million
E)$5.9 million

Question 15

A cost-cutting project will decrease costs by $25 000 a year.The annual depreciation on the project's fixed assets will be $6800 and the tax rate is 34 per cent.What is the amount of the change in the firm's operating cash flow created by this project?

A)-$14 188
B)-$6212
C)$10 812
D)$18 812
E)$20 988

Question 16

Start-up costs to introduce a new project includes $200 000 to buy new production equipment and $100 000 to fully install and integrate this equipment.The equipment has an economic life of four years and the company will depreciate it for taxation purposes at 10% prime cost per annum.The equipment is expected to have a salvage value of $55 000 after four years of use.The corporate tax rate is 35%.Calculate the tax effect on salvage cash flows at the final (fourth)year of the project.

A)no tax effect on cash flows
B)decrease of cash flow of $19 250
C)increase of cash flow of $43 750
D)decrease of cash flow of $43 750
E)increase of cash flow of $19 250

Question 17

Wislon and Taylor are implementing a project which will increase accounts payable by $5000,increase inventory by $3000,and decrease accounts receivable by $2000.All net working capital will be recouped when the project terminates.What is the cash flow related to the net working capital for the last year of the project?

A)-$10 000
B)-$4000
C)$0
D)$1000
E)$4000

Question 18

The net working capital invested in a project is generally:

A)a sunk cost
B)an opportunity cost
C)recouped in the first year of the project
D)recouped at the end of the project
E)depreciated to a zero balance over the life of the project

Question 19

Shere Khan Corporation is currently evaluating a new project.Relatively inexpensive equipment with an estimated cost of $300 000 would be purchased,but shipping costs to move the equipment would total $25 000 and installation charges would add another $15 000 to the total equipment costs.Further,the company's inventories would have to be increased by $20 000 at the time of initial investment.The straight-line depreciation rate is 20% and corporate tax rate is 25%.What is the cash outflow in Year 0?

A)$20 000
B)$360 000
C)$325 000
D)$340 000
E)$300 000

Question 20

Byrne Corporation generated sales of 1500 bicycles at a selling price of $1000 each.The fixed costs are $800 000 and variable costs per unit are $30.The annual depreciation of the machinery is $150 000.Calculate the annual operating cash flow if the corporate tax rate is 30%.

A)$503 500
B)$655 000
C)$506 500
D)$656 500
E)$505 000

Question 21

Turner Industries started a new project three months ago.Sales arising from this project are exceeding all expectations.Given this,which one of the following is management most apt to implement?

A)option to wait
B)soft rationing
C)strategic option
D)option to abandon
E)option to expand

Question 22

Which of the following should be included when compiling pro forma statements for a proposed investment?
I.forecasted sales
II.start-up costs
III.aftertax salvage value of any assets sold
IV.anticipated changes in net working capital

A)I only
B)II and IV only
C)I,II and III only
D)II,III and IV only
E)I,II,III and IV

Question 23

Browning's Motor Works is reviewing its current accounts to determine how a proposed project might affect the account balances.The firm estimates the project will initially require $57 000 in additional current assets and $32 000 in additional current liabilities.The firm also estimates the project will require an additional $7000 a year in current assets for each one of the four years of the project.How much net working capital will the firm recoup at the end of the project assuming that all net working capital can be recaptured?

A)-$85 000
B)$25 000
C)$53 000
D)$28 000
E)$85 000

Question 24

Ed's Hardware is adding a new product line to its sales line-up.Initially,the firm will stock $31 000 of the new inventory,which will be purchased on 30-days credit from a supplier.The firm will also invest $6000 in accounts receivable and $4000 in equipment.What amount should be included in the initial project costs for net working capital?

A)-$41 000
B)-$37 000
C)-$10 000
D)-$6000
E)-$2000

Question 25

The tax shield approach to computing the operating cash flow,given a tax-paying firm:

A)ignores both interest expense and taxes
B)separates cash inflows from cash outflows
C)considers the changes in net working capital resulting from a new project
D)is based on the fact that depreciation does not affect the operating cash flows
E)recognises that depreciation creates a cash inflow

Question 26

A pro forma financial statement is a financial statement that:

A)expresses all values as a percentage of either total assets or total sales
B)compares actual results to the budgeted amounts
C)compares the performance of a firm to its industry
D)projects future years' operations
E)values all assets based on their current market values

Question 27

The Corner Market has decided to expand its retail store by building on a vacant lot it currently owns.This lot was purchased four years ago at a cost of $299 000,which the firm paid in cash.To date,the firm has spent another $38 000 on land improvements,all of which was also paid in cash.Today,the lot has a market value of $329 000.What value should be included in the analysis of the expansion project for the cost of the land?

A)the sum of the cash paid to date for both the lot and the improvements
B)the original purchase price only
C)the current market value of the land plus the cash paid for the improvements
D)the current market value of the land only
E)zero because the land and the improvements were purchased with cash

Question 28

Sensitivity analysis:

A)looks at the most reasonably optimistic and pessimistic results for a project
B)helps identify the variable within a project that presents the greatest forecasting risk
C)is used for projects that cannot be analysed by scenario analysis because the cash flows are unconventional
D)is generally conducted prior to scenario analysis just to determine if the range of potential outcomes is acceptable
E)illustrates how an increase in operating cash flow caused by changing both the revenue and the costs simultaneously will change the net present value for a project

Question 29

The amount by which a firm's tax bill is reduced as a result of the depreciation expense is referred to as the depreciation:

A)tax shield
B)credit
C)erosion
D)opportunity cost
E)adjustment

Question 30

A 9-year project is expected to generate annual revenues of $114 500,variable costs of $73 600,and fixed costs of $14 000.The annual depreciation is $3500 and the tax rate is 34 per cent.What is the annual operating cash flow?

A)$14 301
B)$14 788
C)$15 052
D)$17 506
E)$18 944

Question 31

Jamie is analysing the estimated net present value of a project under various what-if scenarios.The type of analysis that Jamie is doing is best described as:

A)sensitivity analysis
B)erosion planning
C)scenario analysis
D)benefit planning
E)opportunity evaluation

Question 32

Which of the following are cash inflows from net working capital?
I.increase in accounts payable
II.increase in inventory
III.decrease in accounts receivable
IV.decrease in fixed assets

A)II only
B)III only
C)I and III only
D)III and IV only
E)I,II and III only

Question 33

Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as which one of the following?

A)eroded cash flows
B)deviated projections
C)incremental cash flows
D)directly impacted flows
E)assumed flows

Question 34

Forecasting risk is best defined as:

A)reality risk
B)value risk
C)potential risk
D)management risk
E)estimation risk

Question 35

Scenario analysis:

A)determines the impact a $1 change in sales has on the internal rate of return
B)determines which variable has the greatest impact on a project's net present value
C)helps determine the reasonable range of expectations for a project's anticipated outcome
D)evaluates a project's net present value while sensitivity analysis evaluates a project's internal rate of return
E)determines the absolute worst and absolute best outcome that could ever occur

Question 36

Mark is analysing a proposed project to determine how changes in the variable costs per unit would affect the project's net present value.What type of analysis is Mark conducting?

A)sensitivity analysis
B)erosion planning
C)scenario analysis
D)cost-benefit analysis
E)opportunity cost analysis

Question 37

The Shoe Box is considering adding a new line of winter footwear to its product line-up.Which of the following are relevant cash flows for this project?
I.decreased revenue from products currently being offered if this new footwear is added to the line-up
II.revenue from the new line of footwear
III.money spent to date looking for a new product line to add to the store's offerings
IV.cost of new counters to display the new line of footwear

A)I and IV only
B)II and IV only
C)II and III only
D)I,II and IV only
E)II,III and IV only

Question 38

Which one of the following principles refers to the assumption that a project will be evaluated based on its incremental cash flows?

A)forecast assumption principle
B)base assumption principle
C)fallacy principle
D)erosion principle
E)stand-alone principle

Question 39

Which one of the following terms refers to the best option that was foregone when a particular investment is selected?

A)side effect
B)erosion
C)sunk cost
D)opportunity cost
E)marginal cost

Question 40

The managers of H.R Construction are considering remodelling plans for an old building the firm currently owns.The building was purchased eight years ago for $689 000.Over the past eight years,the firm rented out the building and used the rent to pay off the mortgage.The building is now owned free and clear and has a current market value of $898 000.The firm is considering remodelling the building into a conference centre and sandwich bar at an estimated cost of $1.7 million.The estimated present value of the future income from this centre is $2.9 million.Which one of the following defines the opportunity cost of the remodelling project?

A)initial cost of the building
B)cost of the remodelling
C)current market value of the building
D)initial cost of the building plus the remodelling costs
E)current market value of the building plus the remodelling costs

Question 41

Aussie Home Entertainment Pty Ltd is setting up a new franchised store in an outer suburb of Sydney.This project has an initial requirement of $261 000 for fixed assets and $27 000 for net working capital.The fixed assets will be depreciated to a zero book value over the four-year life of the project and have an estimated salvage value of $78 000.All of the net working capital will be recouped at the end of the project.The annual operating cash flow is $96 200 and the discount rate is 13 per cent.What is the project's net present value if the tax rate is 30 per cent?

A)$41 011
B)$45 725
C)$48 191
D)$50 880
E)$50 991

Question 42

Lakeside Winery is considering expanding its wine-making operations.The expansion will require new equipment costing $649 000 that would be depreciated on a straight-line basis to a zero balance over the four-year life of the project.The estimated salvage value is $187 000.The project requires $38 000 initially for net working capital,all of which will be recouped at the end of the project.The projected operating cash flow is $198 500 a year.What is the net present value of this project if the relevant discount rate is 14 per cent and the tax rate is 35 per cent?

A)-$14 162
B)-$8309
C)-$2747
D)$2311
E)$3615

Question 43

The Bondi Pizza Palace is looking at a new pizza oven with an installed cost of $438 000.This cost will be depreciated straight-line to zero over the project's four-year life,at the end of which the system can be scrapped for $69 000.The pizza system will save the firm $129 000 per year in pre-tax operating costs,and the system requires an initial investment in net working capital of $29 000,which will be recouped at project end.If the tax rate is 35 per cent and the discount rate is 9 per cent,what is the NPV of this project?

A)-$18 870
B)-$6320
C)$2560
D)$14 410
E)$26 880

Question 44

Fivedock Furniture Pty Ltd is contemplating the purchase of a new $674 000 computer-based order entry system.The system will be depreciated straight-line to zero over its six-year life.It will be worth $58000 at that time.The company will save $185 000 before taxes per year in order processing costs,and will be able to reduce working capital by $29 000 at the beginning of the project.Working capital will revert back to normal at the end of the project.If the tax rate is 34 per cent,what is the IRR for this project?

A)12.51 per cent
B)12.79 per cent
C)13.01 per cent
D)13.53 per cent
E)14.20 per cent

Question 45

Outdoor Sports is considering adding a miniature golf course to its facility.The course would cost $138 000,would be depreciated on a straight line basis over its five-year life,and would have a zero salvage value.The estimated income from the golfing fees would be $72 000 a year with $24 000 of that amount being variable cost.The fixed cost would be $11 600.In addition,the firm anticipates an additional $14 000 in revenue from its existing facilities if the golf course is added.The project will require $3 000 of net working capital,which is recoverable at the end of the project.What is the net present value of this project at a discount rate of 12 per cent and a tax rate of 34 per cent?

A)$11 309
B)$11 628
C)$12 737
D)$14 439
E)$14 901

Question 46

Billy's Plumbing Supplies is considering the purchase of an asset that costs $450 000 and is depreciated straight-line to zero over its six-year tax life.The asset is to be used in a four-year project;at the end of the project,the asset can be sold for $120 000.If the relevant tax rate is 30 per cent,what is the after-tax cash flow from the sale of this asset?

A)$129 000
B)$111 000
C)$150 000
D)$45 000
E)$165 000

Question 47

Billy's Plumbing Supplies is considering the purchase of an asset that costs $450 000 and is depreciated straight-line to zero over its six-year tax life.The asset is to be used in a four-year project;at the end of the project,the asset can be sold for $120 000.If the relevant tax rate is 30 per cent,what is the depreciation tax shield over the life of this asset of this asset?

A)-$22 500
B)-$75 000
C)$75 000
D)$52 500
E)$22 500

Question 48

Which one of the following statements is correct when a firm faces hard rationing?

A)All positive net present value projects will be accepted.
B)Each division within a firm will be allocated an amount for capital expenditures that will be less than the total value of its positive net present value projects.
C)The firm does not have funds to finance any new projects.
D)The firm will fund only those projects that create value for its shareholders.
E)The firm will only finance the projects which have the highest profitability index values.

Question 49

Ignoring the option to wait:

A)may overestimate the internal rate of return on a project
B)may underestimate the net present value of a project
C)ignores the ability of a manager to increase output after a project has been implemented
D)is the same as ignoring all strategic options
E)ignores the value of discontinuing a project early

Question 50

Fredo's Fabulous Pies are considering an investment in a new outlet in Sydney and the accountants have assembled the following information: initial fixed asset investment = $770 000;straight-line depreciation to zero over the three-year life;zero salvage value;selling price = $34.99 per pack;variable costs = $23.16 per pack;fixed costs = $245 000;quantity sold = 94 500 packs;tax rate = 35 per cent.How sensitive is OCF to an increase of one pack in the quantity sold?

A)$7.69
B)$8.38
C)$8.67
D)$9.97
E)$11.83