Question 1

A local restaurant owner is considering expanding into another urban area.The expansion project will be financed through a line of credit with First National Bank.The administrative costs of obtaining the line of credit are $500,and the interest payments are expected to be $1,000 per month.The new restaurant will occupy an existing building that can be rented for $2,500 per month.The incremental cash flows for the new restaurant include

Accepted Answer

The answer of A local restaurant owner is considering expanding...

Question 2

The initial outlay includes the cost of purchasing the asset and getting it operational,including the purchase price,shipping and installation,and any training costs for employees who will be operating the equipment,and any increases in working capital requirements.

Accepted Answer

The initial outlay includes all of these costs as they are necessary to acquire and make use of the asset.

Question 3

Taste Good Chocolates develops a new candy bar and plans to sell each bar for $1.Taste Good predicts that 1 million candy bars will be sold in the first year if the new candy bar is produced and sold,and includes $1 million of incremental revenues in its capital budgeting analysis.A senior executive in the company believes that 1 million candy bars will be sold,but lowers the estimate of incremental revenue to $700,000.What would explain this change?

Accepted Answer

Cannibalization of 300,000 of Taste Good Chocolates' other candy bars would result in a decrease in incremental revenue as some of the sales of the new candy bar would come at the expense of sales of the company's other candy bars.

Question 4

JW Enterprises is considering a new marketing campaign that will require the addition of a new computer programmer and new software.The programmer will occupy an office in JW's current building and will be paid $8,000 per month.The software license costs $1,000 per month.The rent for the building is $4,000 per month.JW's computer system is always on,so running the new software will not change the current monthly electric bill of $900.The incremental expenses for the new marketing campaign are

Accepted Answer

The answer of JW Enterprises is considering a new marketing...

Question 5

An opportunity cost is a relevant incremental cost for capital budgeting decisions.

Accepted Answer

Opportunity cost is a relevant cost to consider when making capital budgeting decisions because it represents the cost of forgoing the next best alternative. By considering the opportunity cost, a company can make a more informed decision about whether to invest in a particular project or allocate their resources elsewhere.

Question 6

A project's annual free cash flow is the change in operating cash flow less any change in net working capital and less any change in capital spending.

Accepted Answer

This is the correct definition of a project's annual free cash flow. It is calculated as (change in operating cash flow) - (change in net working capital) - (change in capital spending) for a specific year.

Question 7

Depreciation expense produces a cash inflow equal to the depreciation expense multiplied by the firm's marginal tax rate.

Accepted Answer

The answer of Depreciation expense produces a cash inflow equal...

Question 8

You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from Equipment Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the initial outlay required to fund this project?

Accepted Answer

The initial outlay includes the cost of the equipment ($80,000), the modification cost ($10,000), and the increase in net working capital ($4,000), totaling $94,000. The consulting fee is a sunk cost and not included in the initial outlay.

Question 9

TRL,Inc.has spent $2,000,000 in nonrefundable engineering fees in contemplation of building a convention center and the additional costs to complete the project are $18,000,000.The present value of all benefits the center will produce in its lifetime are $19,000,000,so TRL should not build the convention center.

Accepted Answer

The total cost of the project (engineering fees + additional costs) is $20,000,000. The present value of benefits exceeds this cost, indicating that TRL should build the convention center.

Question 10

Changes in capital spending are not incorporated directly into capital budgeting problems because the amounts are included in the operating cash flows through the inclusion of depreciation expense.

Accepted Answer

Capital spending changes are directly incorporated into capital budgeting problems as initial outlays or investments, not through operating cash flows or depreciation. Depreciation affects tax calculations but does not represent a cash outflow itself.

Question 11

Margo Inc.wants to replace a 9-year-old machine with a new machine that is more efficient.The old machine cost $70,000 when new and has a current book value of $15,000.Margo can sell the machine to a foreign buyer for $14,000.Margo's tax rate is 35%.The effect of the sale of the old machine on the initial outlay for the new machine is

Accepted Answer

The correct answer is A because the effect of the sale of the old machine on the initial outlay for the new machine is ($14,350). This is calculated as follows:Book value of old machine: $15,000Sale price of old machine: $14,000Tax on gain from sale: $35% x ($14,000 - $15,000) = $350Net proceeds from sale: $14,000 - $350 = $13,650Initial outlay for new machine: $70,000 - $13,650 = $56,350Effect of sale of old machine on initial outlay: $56,350 - $70,000 = ($14,350)

Question 12

The initial outlay includes the cost of purchasing the asset and getting is operational,but this excludes any training costs for employees which should be included as part of differential cash flows over the life of the project.

Accepted Answer

The statement is incorrect. Training costs should be included as part of initial outlay, not differential cash flows over the life of the project.

Question 13

You are analyzing the purchase of new equipment.Since you are not an expert on this type of equipment,you hire a consulting firm to make recommendations.The consultant charged you $1,500 and recommended the purchase of the latest model from Equipment Corp.of America.The equipment costs $80,000,and it will cost another $10,000 to modify it for special use by your firm.The equipment will be depreciated on a straight-line basis over six years with no salvage value.You expect the equipment will be sold after three years for $28,000.Use of the equipment will require an increase in your company's net working capital of $4,000,but this $4,000 will be recovered at the end of year three.The use of the equipment will have no effect on revenues,but it is expected to save the firm $50,000 per year in before-tax operating costs.Your company's marginal tax rate is 35%.What is the incremental free cash flow for the first year of the project?

Accepted Answer

The answer of You are analyzing the purchase of new...

Question 14

In general,a project's free cash flows will fall into one of three categories:
 (1)incremental costs,(2)sunk costs,and (3)opportunity costs.

Accepted Answer

Incremental cash flows are relevant for project evaluation, but sunk costs and opportunity costs are different concepts. Sunk costs are past costs that cannot be recovered and should not be considered in project evaluation. Opportunity costs represent the benefits foregone by choosing one alternative over another, but they are not a category of free cash flows. Free cash flows typically refer to the cash that a project is expected to generate after accounting for all expenses, including opportunity costs, but excluding sunk costs.

Question 15

Increases in inventory and accounts receivable expected to occur if a proposed advertising campaign is undertaken are examples of sunk costs.

Accepted Answer

This is incorrect. Increases in inventory and accounts receivable are not examples of sunk costs. Sunk costs are costs that have already been incurred and cannot be recovered, regardless of whether the proposed advertising campaign is undertaken or not. Examples of sunk costs include past advertising expenses, depreciation of equipment, and salaries of employees who have already been paid.

Question 16

In a replacement decision,the initial outlay is equal to the cost of the new asset less the reduction in depreciation from elimination of the old asset.

Accepted Answer

In a replacement decision, the initial outlay is equal to the cost of the new asset less the salvage value of the old asset, not the reduction in depreciation.

Question 17

Laural Inc.is a household products firm that is considering developing a new detergent.In evaluating whether to go ahead with the new detergent project,which of the following statements is most correct?

Accepted Answer

The cost of renovating the building for $300,000 should not be excluded from the analysis as it is a sunk cost, meaning it has already been incurred and cannot be recovered. The cost should be considered in the analysis as it is a relevant cost that will affect the profitability of the project. Choices A, B, and C are incorrect as all of the mentioned costs are relevant and should be included in the analysis.

Question 18

Capital budgeting projects that expand sales are more likely to involve increases in working capital than are projects that involve the replacement of existing assets.

Accepted Answer

Projects that expand sales often require additional investment in inventory, accounts receivable, and other working capital items to support the increased sales volume, while replacement projects are typically done to maintain existing production levels and may not require as much additional working capital.

Question 19

Free cash flow calculations can be broken down into three parts:
 cash flows from operations,cash flows associated with working-capital requirements,and financing cash flows relating to interest and dividend payments.

Accepted Answer

Free cash flow calculations typically consist of cash flows from operations and cash flows associated with investing activities (such as capital expenditures), not financing cash flows related to interest and dividend payments.

Question 20

Operating cash flow is equal to the change in EBIT less the change in interest expense,less the change in taxes,plus the change in depreciation.

Accepted Answer

Operating cash flow is calculated as net income plus non-cash expenses (such as depreciation and amortization) and changes in working capital, not as the change in EBIT less the change in interest expense, less the change in taxes, plus the change in depreciation.

Quiz 11: Cash Flows and Other Topics in Capital Budgeting