Question 1

A piece of capital equipment costing $400,000 today has no (zero) salvage value at the end of five years.If straight-line depreciation is used, what is the book value of the equipment at the end of three years?
A)$120,000
B)$80,000
C)$160,000
D)$240,000

Accepted Answer

Straight-line depreciation means that the cost of the equipment will be equally spread out over the five years, so the yearly depreciation is $80,000 ($400,000 divided by 5).
After three years, the accumulated depreciation will be $240,000 ($80,000 per year times 3 years), and the book value of the equipment will be:
$400,000 (original cost) - $240,000 (accumulated depreciation) = $160,000. Therefore, the best choice is C.

Question 2

Capital equipment costing $250,000 today has $50,000 salvage value at the end of five years.If the straight-line depreciation method is used, what is the book value of the equipment at the end of two years?
A)$200,000
B)$170,000
C)$140,000
D)$150,000

Accepted Answer

The straight-line depreciation method spreads the cost of the equipment evenly over its useful life. The annual depreciation is calculated as (Cost - Salvage Value) / Useful Life = ($250,000 - $50,000) / 5 = $40,000 per year. After two years, the total depreciation is $40,000 * 2 = $80,000. Therefore, the book value at the end of two years is Cost - Accumulated Depreciation = $250,000 - $80,000 = $170,000.

Question 3

A firm has a general-purpose machine, which has a book value of $300,000 and is worth $500,000 in the market.If the tax rate is 35 percent, what is the opportunity cost of using the machine in a project?
A)$500,000
B)$430,000
C)$300,000
D)$200,000

Accepted Answer

The opportunity cost of using the machine in the project is equal to the market value of the machine, which is $500,000. However, there is also a tax implication on the machine, since it has a book value of $300,000. If the firm uses the machine, it will no longer be able to sell the machine at the market value of $500,000, and if it sells the machine, it will have to pay taxes on the difference between the market value and the book value. Therefore, the opportunity cost of using the machine in the project is the after-tax value of the machine, which is:
$500,000 - (0.35 x ($500,000 - $300,000)) = $430,000. Thus, the best choice is B.

Question 4

The real interest rate is 3 percent and the inflation rate is 5 percent.What is the nominal interest rate?
A)3.00 percent
B)5.00 percent
C)8.15 percent
D)2.00 percent

Accepted Answer

The nominal interest rate is the sum of the real interest rate and the inflation rate. Therefore, the nominal interest rate is 3 percent + 5 percent = 8 percent. However, we need to use the equation for approximate calculations, which is (1 + real interest rate) x (1 + inflation rate) - 1. Plugging in the values, we get (1 + 0.03) x (1 + 0.05) - 1 = 1.0815 - 1 = 0.0815 or 8.15 percent. Therefore, the best choice is C.

Question 5

The NPV value obtained by discounting nominal cash flows using the nominal discount rate is the same as the NPV value obtained by discounting
A)real cash flows using the real discount rate only.
B)real cash flows using the nominal discount rate only.
C)nominal cash flows using the real discount rate only.
D)real cash flows using the nominal discount rate and nominal cash flows using the real discount rate.

Accepted Answer

The NPV value obtained by discounting nominal cash flows using the nominal discount rate can be converted into real cash flows by adjusting for inflation using the inflation rate. Therefore, it is equivalent to the NPV value obtained by discounting real cash flows using the real discount rate. Option A is the correct choice because it discounts real cash flows using the real discount rate only. Option B is incorrect because it uses the nominal discount rate instead of the real discount rate. Option C is incorrect because it discounts nominal cash flows using the real discount rate instead of the nominal discount rate. Option D is incorrect because it discounts both nominal and real cash flows using different discount rates, which does not provide a consistent measurement.

Question 6

If depreciation is $100,000 and the marginal tax rate is 35 percent, then the tax shield due to depreciation is
A)$35,000.
B)$100,000.
C)$65,000.
D)The answer cannot be determined from the information given.

Accepted Answer

The tax shield is calculated as depreciation multiplied by the tax rate: $100,000 * 0.35 = $35,000.

Question 7

For project A in year 2, inventories increase by $12,000 and accounts payable increase by $2,000.Accounts receivable remain the same.Calculate the increase or decrease in net working capital for year 2.
A)Decreases by $14,000
B)Increases by $14,000
C)Decreases by $10,000
D)Increases by $10,000

Accepted Answer

Net working capital is calculated as current assets minus current liabilities. The increase in inventories ($12,000) increases current assets, while the increase in accounts payable ($2,000) increases current liabilities. The net effect is an increase in net working capital by $10,000 ($12,000 - $2,000). Accounts receivable remaining the same does not affect the calculation.

Question 8

The real cash flow occurring in year 2 is $60,000.If the inflation rate is 5 percent per year and the real rate of interest is 2 percent per year, calculate the nominal cash flow for year 2.
A)$60,000
B)$62,424
C)$66,150
D)$63,654

Accepted Answer

Using the Fisher equation, we can find the nominal interest rate as follows:
(1 + nominal rate) = (1 + real rate) × (1 + inflation rate)
(1 + nominal rate) = (1 + 0.02) × (1 + 0.05)
(1 + nominal rate) = 1.07 × 1.02
(1 + nominal rate) = 1.0914
nominal rate = 0.0914 or 9.14%
To find the nominal cash flow, we multiply the real cash flow by the ratio of the nominal cash flow in year 2 to the real cash flow in year 2:
Nominal cash flow = Real cash flow × (1 + inflation rate)
Nominal cash flow in year 2 = $60,000 × (1 + 0.05) = $63,000
The ratio of nominal to real cash flow is:
Nominal cash flow in year 2 / Real cash flow in year 2
$63,000 / $60,000 = 1.05
Therefore, the nominal cash flow in year 2 is:
Nominal cash flow in year 2 = Real cash flow in year 2 × (Nominal cash flow in year 2 / Real cash flow in year 2)
= $60,000 × 1.05 = $66,150
Hence, the best choice is C.

Question 9

Suppose that a project has a depreciable investment of $1,000,000 and falls under the following MACRS year 5 class depreciation schedule: year 1: 20 percent; year 2: 32 percent; year 3: 19.2 percent; year 4: 11.5 percent; year 5: 11.5 percent; and year 6: 5.8 percent.
Calculate the depreciation tax shield for year 2 using a tax rate of 30 percent.
A)$224,000
B)$60,000
C)$96,000
D)$300,000

Accepted Answer

The depreciation tax shield for year 2 can be calculated as follows:
Depreciation in year 2 = $1,000,000 * 32% = $320,000
Tax shield = Depreciation * Tax rate = $320,000 * 30% = $96,000
Therefore, the answer is C.

Question 10

The real rate of interest is 3 percent and inflation is 4 percent.What is the nominal rate of interest?
A)3.00 percent
B)1.00 percent
C)7.12 percent
D)-1.00 percent

Accepted Answer

Nominal rate of interest = Real rate of interest + Inflation. Therefore, nominal rate of interest = 3% + 4% = 7%. Hence, the correct answer is C) 7.12 percent (rounded to the nearest hundredth).

Question 11

A project requires an initial investment of $200,000 and expects to produce a cash flow before taxes of $120,000 per year for two years .The corporate tax rate is 30 percent.The assets will depreciate using the MACRS 3-year schedule: (t = 1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%).The company's tax situation is such that it can use all applicable tax shields.The opportunity cost of capital is 12 percent.Assume that the asset can sell for book value at the end of the project.Calculate the NPV of the project (approximately).
A)$22,463
B)$19,315
C)$16,244
D)$5,721

Accepted Answer

The answer of A project requires an initial investment of...

Question 12

Your firm expects to receive a cash flow in two years of $10,816 in nominal terms.If the real rate of interest is 2 percent and the inflation rate is 4 percent, what is the real cash flow for year 2?
A)$11,236
B)$10,816
C)$10,000
D)$9,246

Accepted Answer

The real cash flow can be calculated using the formula for adjusting nominal cash flows into real terms, which is: Real Cash Flow = Nominal Cash Flow / (1 + inflation rate)^n. Here, n=2 (since the cash flow is received in two years), the nominal cash flow is $10,816, and the inflation rate is 4% or 0.04. Thus, Real Cash Flow = $10,816 / (1 + 0.04)^2 = $10,816 / 1.0816 = $10,000.

Question 13

If the nominal interest rate is 7.5 percent and the inflation rate is 4.0 percent, what is the real interest rate?
A)4.0 percent
B)9.5 percent
C)3.4 percent
D)11.5 percent

Accepted Answer

Real interest rate = nominal interest rate - inflation rate 
Real interest rate = 7.5% - 4.0% = 3.5% or 3.4% (rounded to one decimal place)

Question 14

Suppose that a project has a depreciable investment of $600,000 and falls under the following MACRS year 5 class depreciation schedule: year 1: 20 percent; year 2: 32 percent; year 3: 19.2 percent; year 4: 11.5 percent; year 5: 11.5 percent; and year 6: 5.8 percent.
Calculate depreciation for year 2.
A)$120,000
B)$192,000
C)$96,000
D)$115,200

Accepted Answer

To calculate the depreciation for year 2, we need to find the depreciation rate for year 2 using the MACRS schedule.

Year 1: 20% = 0.20
Year 2: 32% = 0.32
Year 3: 19.2% = 0.192
Year 4: 11.5% = 0.115
Year 5: 11.5% = 0.115
Year 6: 5.8% = 0.058

Depreciation rate for year 2 is 32%.

Depreciation = Depreciation rate x Depreciable investment
Depreciation = 0.32 x $600,000
Depreciation = $192,000

Therefore, the correct answer is B) $192,000.

Question 15

Proper treatment of inflation in NPV calculations involves
A)discounting nominal cash flows by the nominal discount rate.
B)discounting real cash flows by the real discount rate.
C)discounting nominal cash flows by the real discount rate.
D)discounting nominal cash flows by the nominal discount rate and discounting real cash flows by the real discount rate.

Accepted Answer

The correct approach to treating inflation in NPV calculations involves both discounting nominal cash flows by the nominal discount rate and discounting real cash flows by the real discount rate. This ensures that the calculation accurately reflects the time value of money in the presence of inflation.

Question 16

Given the following data for Project M calculate the NPV of the project. 
$\begin{array} { c c c } 
&\mathrm { C } _ { 6 } & \mathrm { C } _ { 1 } & \mathrm { C } _ { 2 } \ 
\text {Cash flow in nominal terms:}&- 100 & 75 & 60 \
\text {Real discount rate = 5 \%}\
\text {Nominal discount rate = 10 \%}\
\end{array}$

A)$25.85
B)$17.77
C)$22.65
D)$35.00

Accepted Answer

To calculate the NPV, discount the cash flows using the nominal discount rate of 10%. NPV = -100 + 75/(1+0.10) + 60/(1+0.10)^2 = $17.77.

Question 17

Given the following data for Project M calculate the NPV of the project. $\begin{array} { l l l c } 
\text { Cash flow in real terms: } & \mathrm { C } _ { 0 } & \mathrm { C } _ { 1 } & \mathrm { C } _ { 2 } \
\text { Real discount rate } = 5 \% & - 200 & 150 & 120 \
\text { Nominal discount rate } = 10 \% & & &
\end{array}$
A)$51.70
B)$35.54
C)$45.21
D)$70.00

Accepted Answer

The NPV is calculated using the real cash flows and the real discount rate: NPV = -200 + 150/(1+0.05) + 120/(1+0.05)^2 = $51.70.

Question 18

If depreciation is $600,000 and the marginal tax rate is 35 percent, then the tax shield due to depreciation is
A)$210,000.
B)$600,000.
C)$390,000.
D)The answer cannot be determined from the information given.

Accepted Answer

The tax shield is calculated as depreciation multiplied by the tax rate: $600,000 * 0.35 = $210,000.

Question 19

For project Z, year 5 inventories increase by $6,000; accounts receivable by $4,000; and accounts payable by $3,000.Calculate the increase or decrease in working capital for year 5.
A)Increases by $5,000
B)Decreases by $1,000
C)Increases by $7,000
D)Decreases by $7,000

Accepted Answer

Working capital is calculated by subtracting current liabilities from current assets. Therefore, the increase in inventories ($6,000) and accounts receivable ($4,000) will increase current assets by a total of $10,000, while the increase in accounts payable ($3,000) will increase current liabilities by $3,000. As a result, working capital will increase by $7,000 ($10,000 - $3,000).

Question 20

Working capital is a frequent source of errors in estimating project cash flows.These errors include
A)forgetting about working capital entirely and forgetting that working capital may change during the life of the project.
B)forgetting about working capital entirely, forgetting that working capital may change during the life of the project, and forgetting that working capital is recovered at the end of the project.
C)forgetting that working capital may change during the life of the project, forgetting that working capital is recovered at the end of the project, and forgetting to depreciate working capital.
D)forgetting about working capital entirely, forgetting that working capital may change during the life of the project, and forgetting to depreciate working capital.

Accepted Answer

Forgetting about working capital entirely and forgetting that working capital may change during the life of the project are common errors in estimating project cash flows. Additionally, it's important to remember that any working capital invested is recovered at the end of the project, which is also commonly forgotten.

Quiz 6: Making Investment Decisions With the Net Present Value Rule

A piece of capital equipment costing $400,000 today has no (zero) salvage value at the end of five years.If straight-line depreciation is used, what is the book value of the equipment at the end of three years?

Capital equipment costing $250,000 today has $50,000 salvage value at the end of five years.If the straight-line depreciation method is used, what is the book value of the equipment at the end of two years?

A firm has a general-purpose machine, which has a book value of $300,000 and is worth $500,000 in the market.If the tax rate is 35 percent, what is the opportunity cost of using the machine in a project?

The real interest rate is 3 percent and the inflation rate is 5 percent.What is the nominal interest rate?

The NPV value obtained by discounting nominal cash flows using the nominal discount rate is the same as the NPV value obtained by discounting

If depreciation is $100,000 and the marginal tax rate is 35 percent, then the tax shield due to depreciation is

For project A in year 2, inventories increase by $12,000 and accounts payable increase by $2,000.Accounts receivable remain the same.Calculate the increase or decrease in net working capital for year 2.

The real cash flow occurring in year 2 is $60,000.If the inflation rate is 5 percent per year and the real rate of interest is 2 percent per year, calculate the nominal cash flow for year 2.

The real rate of interest is 3 percent and inflation is 4 percent.What is the nominal rate of interest?

Your firm expects to receive a cash flow in two years of $10,816 in nominal terms.If the real rate of interest is 2 percent and the inflation rate is 4 percent, what is the real cash flow for year 2?

If the nominal interest rate is 7.5 percent and the inflation rate is 4.0 percent, what is the real interest rate?

Proper treatment of inflation in NPV calculations involves

If depreciation is $600,000 and the marginal tax rate is 35 percent, then the tax shield due to depreciation is

For project Z, year 5 inventories increase by $6,000; accounts receivable by $4,000; and accounts payable by $3,000.Calculate the increase or decrease in working capital for year 5.

Working capital is a frequent source of errors in estimating project cash flows.These errors include