Question 1

Hill Top Lumber Company is considering building a sawmill in the state of Washington because the company doesn't have such a facility to service its growing customer base located on the west coast. When evaluating the acceptability of the project, which of the following would be considered a relevant cash flow that should be included when determining the sawmill's initial investment outlay?
A)Last year, Hill Top spent $75,000 preparing a feasibility study on whether the project should be pursued further; that is, whether the firm should conduct a complete capital budgeting analysis, which is extremely costly.
B)Hill Top estimates that the new sawmill will generate $3 million of new business each year it operates.
C)To raise the funds needed to build the sawmill, Hill Top must issue new bonds.
D)It will cost Hill Top $3 million to clear the land on which the sawmill will be built.
E)It is estimated that $20 million of business from Hill Top's current customers will transfer from existing sawmills to the new sawmill.

Accepted Answer

The cost of clearing the land is a relevant cash flow because it is a direct cost of the initial investment in the sawmill. Choices A, B, C, and E are not relevant cash flows for the initial investment outlay. Choice A is a sunk cost and is not relevant because the feasibility study has already been conducted. Choice B is a future cash flow and is not relevant for the initial investment outlay. Choice C is also not relevant because the cost of issuing new bonds is not a direct cost of the investment in the sawmill. Choice E is also a future cash flow and is not relevant for the initial investment outlay.

Question 2

When evaluating the cash flows associated with a capital budgeting project, the shipping and installation costs associated with the purchase of an asset are included in the computation of the:
A)initial investment outlay, because these expenses are part of the project's depreciable basis.
B)incremental operating cash flows, because shipping and installation costs represent expenses that must be written off annually over the life of the project.
C)terminal cash flows, because these expenses are not paid until the end of the project's life.
D)sunk costs, because these expenses do not affect any cash flows associated with purchasing the project.
E)project's opportunity cost, because these costs increase the potential of the project.

Accepted Answer

Shipping and installation costs are part of the initial investment outlay because they are necessary expenses incurred to acquire the asset, and they increase the depreciable basis of the asset. As such, they should be included in the computation of the project's cash flows.

Question 3

Zinc Corp. is planning to purchase a new machine. The initial investment outlay is expected to be $40,000, and the annual supplemental operating cash flows that the machine is expected to generate during its three-year life are $11,000, $15,000, and $18,000, respectively. The company's required rate of return is 9 percent. Which of the following statements is correct about the machine's net present value (NPV) and the decision of Zinc Corp. should make?
A)Accept the project because NPV = $4,000
B)Reject the project because NPV = -$3,384
C)Accept the project because NPV = -$4,382
D)Reject the project because NPV = $16,981
E)Accept the project because NPV = $76,616

Accepted Answer

To calculate the NPV, we need to discount the cash flows at the required rate of return.

NPV = (-$40,000) + $11,000/(1 + 9%) + $15,000/(1 + 9%)^2 + $18,000/(1 + 9%)^3
NPV = -$40,000 + $9,174.31 + $11,984.33 + $13,790.64
NPV = -$5,050.72

Since the NPV is negative, Zinc Corp. should reject the project.

Question 4

Which of the following statements is correct?
A)A firm has estimated that it will save $40,000 in utility expenses annually if it replaces an old machine with a new, more technologically advanced machine. The $40,000 is a relevant cash flow that should be included in the computation of the machine's supplemental operating cash flows.
B)Inflation does not need to be considered in capital budgeting analyses.
C)The tax deduction associated with a project's depreciation expense is not a relevant cash flow in capital budgeting analyses.
D)The sunk costs associated with a project are relevant cash flows that should be included in capital budgeting analyses.
E)The cost of advertising a product that the firm currently produces and sells is a relevant cash flow that should be included in the evaluation of a new capital budgeting project.

Accepted Answer

The estimated savings of $40,000 in utility expenses is a relevant cash flow as it is a direct result of the capital budgeting decision to replace the old machine with a new one.

Answer: E
 The cost of advertising a current product is not a relevant cash flow for evaluating a new capital budgeting project. The capital budgeting decision focuses on future cash flows and expenses directly related to the new project.

Question 5

Which of the following statements about capital budgeting analyses is correct?
A)The externalities associated with a project represent important marginal cash flows that should be included in the capital budgeting analysis.
B)Only incremental cash flows, which are the cash flows that will change if a project is purchased, should be included in capital budgeting analyses.
C)The term incremental cash flows refers to only the marginal expected cash inflows, not the outflows, associated with a capital budgeting project.
D)Sunk costs often affect accept/reject decisions and, therefore, they should be included in the estimation of the projects' incremental cash flows.
E)A project's opportunity cost does not affect its expected cash flows, and, therefore, should not be included in the estimation of the incremental cash flows.

Accepted Answer

Incremental cash flows, which are the cash flows that will change if a project is purchased, should be included in capital budgeting analyses. Sunk costs and externalities should not be included in the analysis because they are either irrelevant or difficult to quantify. Opportunity cost should be included in the estimation of the incremental cash flows since it represents the foregone return on the next best alternative investment.

Question 6

The incremental cash flows associated with a capital budgeting project that occur only at the start of a project's life are included in the computation of the project's _____. 
A)initial investment outlay
B)terminal cash flows
C)sunk costs
D)supplemental operating cash flows
E)externalities

Accepted Answer

The incremental cash flows that occur at the start of a project's life are considered as initial investment outlay. These cash flows include costs such as equipment purchases, installation costs, and any other initial expenses required to start the project. These costs are not considered as operating cash flows because they occur only once at the start of the project. Therefore, the initial investment outlay is included in the computation of the project's cash flows.

Question 7

Stanton Inc. is considering the purchase of a new machine that will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually. Stanton will use the Modified Accelerated Cost Recovery System (MACRS) method to depreciate the machine, and it has estimated the depreciation expense for the first year as $8,000. Which of the following is the supplemental operating cash flow for the first year? Stanton's marginal tax rate is 40 percent. 
A)$19,000
B)$7,800
C)$6,600
D)$9,800
E)$3,000

Accepted Answer

Supplemental operating cash flow is calculated as Earnings before Depreciation and Taxes (EBDT) plus Depreciation minus Taxes.

EBDT = $6,000

Depreciation = $8,000 according to MACRS method

Taxes = (EBDT - Depreciation) x Tax rate

Taxes = ($6,000 - $8,000) x 40% = -$800

Thus, the supplemental operating cash flow for the first year can be calculated as follows:

Supplemental operating cash flow = EBDT + Depreciation - Taxes = $6,000 + $8,000 - (-$800) = $9,800.

Therefore, the correct answer is D) $9,800.

Question 8

Which of the following statements concerning cash flow evaluation in capital budgeting is correct?
A)When determining a project's terminal cash flows, it is generally assumed that the firm's operations do not return to the same level as they were before the project was purchased.
B)Even though it is a noncash expense, a capital budgeting project's depreciation expense must be computed because it affects the after-tax cash flows of the project.
C)The relevant marginal cash flows associated with a project include depreciation, because it is an annual operating expense that requires a cash payment.
D)Shipping and installation charges are deducted from the purchase price of an asset to compute its depreciable basis.
E)The sunk costs associated with an investment proposal are relevant cash flows for capital budgeting analysis that should be included in the computation of the project's initial investment outlay.

Accepted Answer

Depreciation is a non-cash expense, but it affects the after-tax cash flows of a project since it reduces taxable income. Therefore, it is necessary to compute it when evaluating cash flows in capital budgeting. The other statements are incorrect. It is assumed that the firm's operations will return to their previous level after the project ends, depreciation is not a cash expense and does not require a cash payment, shipping and installation charges are added to the purchase price to compute the depreciable basis, and sunk costs should not be included in the capital budgeting analysis as they are irrelevant to the decision-making process.

Question 9

A project's depreciation expense must be considered when evaluating its incremental operating cash flows because:
A)depreciation represents a tax-deductible cash expense.
B)the firm incurs a cash payment equal to the depreciation expense each year.
C)depreciation has an impact on the taxes paid by the firm, which is a cash flow.
D)depreciation is a sunk cost.
E)depreciation is a fixed cash payment that the firm receives each year.

Accepted Answer

Depreciation is a non-cash expense, but it has a significant impact on the taxes paid by the firm. The depreciation expense is tax-deductible, which reduces the taxable income of the firm, and therefore reduces the taxes paid by the firm. As taxes are a cash flow, the impact of depreciation on taxes must be considered when evaluating a project's incremental operating cash flows.

Question 10

Which of the following mathematical expressions can be used to compute the supplemental operating cash flows? (Δ = delta, which indicates the change in something; t = Period t)
A)Supplemental operating cash flows = ΔCash revenuest − ΔCash expensest − ΔTaxest
B)Supplemental operating cash flows = ΔCash revenuest − ΔCash expensest − ΔDepreciationt
C)Supplemental operating cash flows = ΔCash revenuest − ΔCash expensest + ΔDepreciationt
D)Supplemental operating cash flows = ΔCash revenuest − ΔTaxest
E)Supplemental operating cash flows = ΔCash revenuest − ΔDepreciationt + ΔTaxest

Accepted Answer

Supplemental operating cash flows are calculated by taking the change in cash revenues, subtracting the change in cash expenses, and then subtracting the change in taxes. This formula captures the net change in cash flows from operating activities, excluding non-cash expenses like depreciation.

Question 11

Chovita Motors Corp. is evaluating a machine that costs $100,000. The machine is expected to generate net income equal to $30,000, $90,000, and $50,000, respectively, during the next three years. The machine's annual depreciation expense will be $5,000, $3,000, and $2,000, respectively. In three years, the machine will have a salvage value equal to zero. What is the machine's net present value (NPV) if the Chovita's required rate of return is 10 percent?
A)$63,550
B)$80,000
C)$247,746
D)$47,746
E)$186,135

Accepted Answer

To calculate the NPV, we first need to find the cash flows for each year, which include both the net income and the depreciation expense (since depreciation is a non-cash expense that was subtracted to get net income). Then, we discount those cash flows back to their present value at the 10% required rate of return.Year 1: Net income = $30,000, Depreciation = $5,000, Total cash flow = $30,000 + $5,000 = $35,000Year 2: Net income = $90,000, Depreciation = $3,000, Total cash flow = $90,000 + $3,000 = $93,000Year 3: Net income = $50,000, Depreciation = $2,000, Total cash flow = $50,000 + $2,000 = $52,000Now, discount these cash flows back to their present value:Year 1 PV = $35,000 / (1 + 0.10)^1 = $31,818.18Year 2 PV = $93,000 / (1 + 0.10)^2 = $76,860.58Year 3 PV = $52,000 / (1 + 0.10)^3 = $38,781.22Total PV of cash flows = $31,818.18 + $76,860.58 + $38,781.22 = $147,459.98Subtract the initial investment to get the NPV:NPV = Total PV of cash flows - Initial investment = $147,459.98 - $100,000 = $47,459.98Rounding to the nearest dollar gives an NPV of approximately $47,746, which corresponds to option D.

Question 12

Tech Engineering Company is considering the purchase of a new machine to replace an existing one. The current market value of the old machine is $14,000 and its book value is $5,000. The new machine's cost is $30,000. If the firm's marginal tax rate is 40%, the initial investment outlay for the new machine is _____. 
A)$19,600
B)$30,000
C)$33,600
D)$21,000
E)$44,000

Accepted Answer

The initial investment outlay for the new machine includes the cost of the new machine minus the after-tax salvage value of the old machine. The after-tax salvage value is calculated as the market value of the old machine plus the tax effect on the sale of the old machine (which is the tax on the difference between the market value and the book value). The calculation is as follows: Cost of new machine = $30,000; Market value of old machine = $14,000; Book value of old machine = $5,000; Tax on sale of old machine = (Market value - Book value) * Tax rate = ($14,000 - $5,000) * 40% = $3,600; After-tax salvage value of old machine = Market value - Tax on sale = $14,000 - $3,600 = $10,400; Initial investment outlay = Cost of new machine - After-tax salvage value of old machine = $30,000 - $10,400 = $19,600.

Question 13

Trust Engineering Company is considering the purchase of a new machine to replace an existing, worn machine. The old machine was purchased five years ago at a cost of $20,000, and it is being depreciated on a straight line basis to a salvage value of zero over its 10-year life. The new machine, which costs $30,000, falls into the Modified Accelerated Cost Recovery System (MACRS) 5-year class, and it has an estimated life of five years. If the old machine is replaced with the new machine, the change in depreciation expense that will occur in Year 3 of the new machine's life will be _____. The MACRS rates for 5-year class are Year 1 - 20%, Year 2 - 32%, Year 3 - 19%, Year 4 - 12%, Year 5 - 11%, Year 6 - 6%. 
A)$2,000
B)$7,600
C)$3,700
D)$5,700
E)$18,200

Accepted Answer

The answer of Trust Engineering Company is considering the purchase...

Question 14

A firm is evaluating a new machine to replace one of its existing, older machines. If the old machine is replaced, the change in the annual depreciation expense will be $3,000. The firm's marginal tax rate is 30 percent. Which of the following statements is correct?
A)The depreciation expense does not affect the calculation of the supplemental operating cash flows, so it should not be considered in the analysis of the machine.
B)The depreciation expense can be added to the machine's after-tax net operating income to determine its supplemental operating cash flows.
C)The depreciation expense should be added to the machine's initial investment outlay.
D)The depreciation expense is included in the computation of the machine's terminal cash flows.
E)The depreciation expense should be included in the analysis only if it exceeds the tax expense associated with the machine.

Accepted Answer

The depreciation expense can be added to the machine's after-tax net operating income to determine its supplemental operating cash flows. This is because depreciation is a tax-deductible expense and reduces the firm's taxable income, resulting in a lower tax payment. Therefore, the firm will have more cash available for investment. Adding back the depreciation expense to the net operating income reflects the cash inflow generated by the tax savings.

Question 15

Triblaze Corp. is considering buying a new truck. The cost of the truck is $62,000 (the only initial investment outlay), and the cash savings the new truck is expected to generate during its life are $19,920, $22,800, and $31,280, respectively. Trailblaze's required rate of return is 10 percent. The net present value (NPV) of the truck is _____. 
A)-$2,058.80
B)$12,000.00
C)$122,453.19
D)-$1,546.81
E)$2,543.67

Accepted Answer

The NPV is calculated by discounting the future cash flows back to their present value and subtracting the initial investment. Using a 10% discount rate, the NPV calculation is as follows:NPV = -Initial Investment + (Cash Flow Year 1 / (1 + r)^1) + (Cash Flow Year 2 / (1 + r)^2) + (Cash Flow Year 3 / (1 + r)^3)NPV = -$62,000 + ($19,920 / (1 + 0.10)^1) + ($22,800 / (1 + 0.10)^2) + ($31,280 / (1 + 0.10)^3)NPV = -$62,000 + $18,109.09 + $18,843.80 + $23,500.62NPV = -$62,000 + $60,453.51NPV = -$1,546.49 (rounded to -$1,546.81 due to rounding differences in intermediate steps)

Question 16

Which of the following should be included in the computation of an expansion project's terminal cash flow?
A)Any change in net working capital that was recognized at the time the projectwas purchased
B)The project's externalities
C)The initial cost (purchase price) of the project
D)The opportunity cost of the project
E)The sunk cost associated with the project

Accepted Answer

Any change in net working capital that was recognized at the time the project was purchased should be included in the computation of an expansion project's terminal cash flow because it represents the difference between the current level of working capital and the level of working capital needed at the end of the project. It is important to consider this because it may affect the cash inflows and outflows at the end of the project. The other choices (B, C, D, and E) are not related to the computation of the terminal cash flow.

Question 17

To expand sales, Sandine Corporation is evaluating whether to purchase a machine to manufacture a new product line. Which of the following statements is correct concerning an expansion analysis like the one Sandine faces?
A)The machine's annual depreciation expenses will be deducted from the firm's net income to calculate its supplemental operating cash flows.
B)The new machine will be acceptable as long as the sum of its net cash flows is positive.
C)The shipping and installation costs associated with purchasing the new machine are included in the computation of its initial investment outlay.
D)The cost of a feasibility study that Sandine conducted last year to determine whether to further evaluate the introduction of the new product line should be included in the calculation of the new machine's initial investment outlay.
E)The salvage value of the new machine should be included in the computation of its initial investment outlay.

Accepted Answer

Shipping and installation costs associated with purchasing the new machine are considered as part of the initial investment outlay. The annual depreciation expenses will be considered in calculating the expenses but not while making a decision to purchase the machine. The new machine must generate a positive net cash flow, but this alone may not make it acceptable to the company. The cost of the feasibility study conducted last year is a sunk cost and is not relevant to the decision. The salvage value of the new machine is considered while calculating net present value or internal rate of return but not while calculating initial investment outlay.

Question 18

Which of the following statements about the opportunity cost associated with a capital budgeting project is correct?
A)A project's opportunity cost is a cash outlay that the firm has already paid; therefore, it should not be included in a capital budgeting analysis.
B)The terms sunk cost and opportunity cost generally are used interchangeably.
C)A project's opportunity cost is the return (cash flow) that will not be earned (generated) if funds are invested in a particular capital budgeting project.
D)A project's opportunity cost is not a relevant cash flow, therefore it should not be included in the capital budgeting analysis.
E)A project's opportunity cost reflects the change in a firm's net cash flow that is attributable to purchasing the project.

Accepted Answer

A project's opportunity cost is the potential return (cash flow) that will not be earned (generated) if funds are invested in a particular capital budgeting project. This cost should be considered in the analysis since it represents the foregone opportunity to earn a return by investing in an alternative project or investment. Sunk costs, on the other hand, are costs that have already been incurred and should not be considered in the analysis since they cannot be recovered.

Question 19

Which of the following is not relevant in a capital budgeting analysis because it is not an incremental cash flow?
A)Changes in the firm's net working capital
B)Externalities
C)Shipping and installation costs associated with the purchase of a capital budgeting project
D)Purchase price of a capital budgeting project
E)Salvage value of a capital budgeting project

Accepted Answer

Externalities are costs or benefits that affect a party who did not choose to incur that cost or benefit. While they can impact the overall economy or society, they are not considered incremental cash flows directly associated with a capital budgeting project's cash flow analysis. Incremental cash flows are the additional cash flows—outflows or inflows—expected to result from a capital budgeting decision, directly affecting the project's profitability.

Question 20

Stonewood Manufacturing is evaluating whether to replace one of its existing machines with a new, more technologically advanced one. Which of the following statements concerning a replacement decision analysis is correct?
A)When computing the supplemental operating cash flows associated with the purchase of the new machine, only the after-tax cash flows that the new machine is expected to generate each year should be included in the computation.
B)The net cash flow from the sale of old machine should be included as part of the new machine's initial investment outlay.
C)The annual depreciation expense associated with the new machine should be included in the computation of the new machine's terminal cash flow.
D)If the old machine is sold for a loss when it is replaced, the loss is treated as a cash outflow in the computation of the new machine's initial investment outlay.
E)An increase in the net working capital that occurs when the new machine is purchased is treated as a cash inflow when its initial investment outlay is computed.

Accepted Answer

The net cash flow from the sale of the old machine should be included as part of the new machine's initial investment outlay. This is because the sale of the old machine will generate cash inflows that can offset the initial investment required for the new machine. The other statements are not correct. A) The before-tax cash flows should also be included in the computation of the supplemental operating cash flows. C) The annual depreciation expense would affect the operating cash flows, but not the terminal cash flow. D) The loss from the sale of the old machine would be a cash inflow, not a cash outflow. E) An increase in net working capital represents a cash outflow, not a cash inflow.

Quiz 10: Project Cash Flows and Risk

When evaluating the cash flows associated with a capital budgeting project, the shipping and installation costs associated with the purchase of an asset are included in the computation of the:

Which of the following statements is correct?

Which of the following statements about capital budgeting analyses is correct?

The incremental cash flows associated with a capital budgeting project that occur only at the start of a project's life are included in the computation of the project's _____.

Which of the following statements concerning cash flow evaluation in capital budgeting is correct?

A project's depreciation expense must be considered when evaluating its incremental operating cash flows because:

Which of the following mathematical expressions can be used to compute the supplemental operating cash flows? (Δ = delta, which indicates the change in something; t = Period t)

A firm is evaluating a new machine to replace one of its existing, older machines. If the old machine is replaced, the change in the annual depreciation expense will be $3,000. The firm's marginal tax rate is 30 percent. Which of the following statements is correct?

Which of the following should be included in the computation of an expansion project's terminal cash flow?

To expand sales, Sandine Corporation is evaluating whether to purchase a machine to manufacture a new product line. Which of the following statements is correct concerning an expansion analysis like the one Sandine faces?

Which of the following statements about the opportunity cost associated with a capital budgeting project is correct?

Which of the following is not relevant in a capital budgeting analysis because it is not an incremental cash flow?

Stonewood Manufacturing is evaluating whether to replace one of its existing machines with a new, more technologically advanced one. Which of the following statements concerning a replacement decision analysis is correct?