Question 1

At the beginning of the year, the Personnel Department hired new staff. Six months later, one of the new staff members has been re-assigned to work on your project. How should the salary of the staff member be considered within the cost structure of your project?

Accepted Answer

Since the staff member is now working on your project, their salary is considered as part of the operating budget within the project. The cost of their salary should be included in the project's salary expense. This is not a sunk cost because the individual is still working for the company and is providing value to the project. It should also not be part of the Personnel Department's budget, as they are now working on a specific project and their salary should be allocated accordingly. Therefore, the correct answer is D.

Question 2

Cash flow estimation concerns:

Accepted Answer

Cash flow estimation concerns the prediction of future cash flows associated with potential projects or investments. While both NPV and IRR are commonly used methods for evaluating the potential profitability of projects, they are not directly related to cash flow estimation. Therefore, the best choice is A.

Question 3

Cash flows that are forecasted to continue forever are compressed into _____ using perpetuity formulas.

Accepted Answer

The answer of Cash flows that are forecasted to continue...

Question 4

When comparing a five year straight-line depreciation schedule and a five year MACRS depreciation schedule, at what point in time does the straight-line depreciation cost exceed the MACRS depreciation cost?

Accepted Answer

The straight-line depreciation method spreads the cost evenly over the asset's useful life, while MACRS front-loads depreciation, allowing for greater depreciation expenses in the early years. Therefore, straight-line depreciation cost exceeds MACRS depreciation cost after the second year, as MACRS' accelerated depreciation decreases over time.

Question 5

A project increases accounts receivable and accounts payable by $500,000.00 each. All other working capital accounts are unaffected. What is the project's effect on working capital?

Accepted Answer

Working capital is calculated as current assets minus current liabilities. Since the increase in accounts receivable is offset by the increase in accounts payable, there is no net change to current assets or current liabilities, and therefore no net change to working capital.

Question 6

Initial outlay:

Accepted Answer

The initial outlay refers to the total cost required to make an investment, which includes both expenses and assets that have to be purchased, such as equipment, property, and supplies. Therefore, choice A is the best answer as it accurately describes the components of the initial outlay.

Question 7

Only _____cash flows count in relation to a project under consideration.

Accepted Answer

Incremental cash flows are the only cash flows that are relevant to a project under consideration. Incremental cash flows are the additional cash flows that are generated by a project and are directly attributable to the project. These cash flows take into account the cash that is required to finance the project, as well as any cash flows that are lost from abandoning an existing project or asset, also known as opportunity costs. Marginal cash flows, on the other hand, refer to the change in cash flows resulting from a specific decision, while fractional and subsidiary cash flows are not relevant to the project evaluation process.

Question 8

The basic capital budgeting principles involved in determining after-tax incremental operating cash flows require us to:

Accepted Answer

The basic capital budgeting principle involves including incremental cash flows, including opportunity costs and ignoring sunk costs. Sunk costs are irrelevant to future decision-making and should not be included in determining the incremental cash flows. Opportunity costs refer to the potential benefits that are foregone due to choosing one alternative over the other. These costs should be considered while determining the incremental cash flows. Hence, option B is the correct choice.

Question 9

Subjective benefits:

Accepted Answer

The answer of Subjective benefits:
...

Question 10

If there are no taxes, would depreciation and opportunity costs be relevant in assessing a project's cash flows?

Accepted Answer

Depreciation is a non-cash expense that reduces taxable income in a company's financial statements. If there are no taxes, then depreciation would not have any impact on the cash flows. However, opportunity costs would still be relevant in assessing a project's cash flows, as they represent the forgone benefits from choosing one alternative over another.

Question 11

If a project is being evaluated three years after it had started, how should the costs of the project from the three previous years be considered in deciding whether to continue the project?

Accepted Answer

These costs are considered sunk costs because they have already been incurred and cannot be recovered, so they should not influence the decision on whether to continue the project. The decision should be based on future costs and benefits.

Question 12

Estimating cash flows is the _____ and error-prone part of capital budgeting.

Accepted Answer

Estimating cash flows involves predicting future cash inflows and outflows, which can be difficult due to uncertainties and changes in market conditions. It is also prone to error, as small inaccuracies in the estimates can significantly affect the outcome of capital budgeting decisions.

Question 13

A company purchased land ten years ago for $250,000.00, but never built the factory that was originally intended for the property. The property currently has a value of $750,000.00. Assuming a 35% tax rate, what is the opportunity cost of using the property?

Accepted Answer

The opportunity cost of using the property is the current value of the property ($750,000.00) minus the purchase price ($250,000.00), which equals $500,000.00. However, the question asks for the opportunity cost after considering a 35% tax rate. The tax on the gain ($500,000.00) would be $500,000.00 * 35% = $175,000.00. Therefore, the net opportunity cost after tax would be $500,000.00 - $175,000.00 = $325,000.00.

Question 14

Based on a five year MACRS depreciation schedule, depreciation will occur over a ____ period.

Accepted Answer

Under the Modified Accelerated Cost Recovery System (MACRS), assets categorized in a five-year schedule actually depreciate over six years. This is because MACRS allows for a half-year convention, counting only a half year's worth of depreciation in both the first and last year of the schedule.

Question 15

PanAfrica Construction bought a small crane ten years ago for $140,000. The crane is being depreciated over a 15-year life to a salvage value of $20,000. PanAfrica pays taxes equal to 40 percent of ordinary income and capital gains. What is the tax liability (or saving) if the crane is sold now for $92,000?

Accepted Answer

The crane's original cost is $140,000, with a salvage value of $20,000 and a 15-year life. The annual depreciation is ($140,000 - $20,000) / 15 = $8,000. After 10 years, the total depreciation is 10 * $8,000 = $80,000. The book value of the crane now is $140,000 - $80,000 = $60,000. Selling the crane for $92,000 results in a gain of $92,000 - $60,000 = $32,000. The tax on this gain at 40% is $32,000 * 0.4 = $12,800.

Question 16

A piece of machinery can be further depreciated $2,000.00 annually for the next four years. Assuming a 10% discount rate and a 40% tax rate, what is the current value of the benefit of depreciation?

Accepted Answer

To calculate the current value of the benefit of depreciation, we need to use the formula:
Current value = Depreciation amount x Present value factor
Where present value factor is calculated using the discount rate and number of years.

Given, Depreciation amount = $2,000.00 annually for 4 years, Discount rate = 10%, Tax rate = 40%

Using the formula for present value factor:
PVF = 1/(1+r)^n
where r = discount rate, n = number of years

PVF = 1/(1+0.10)^1 + 1/(1+0.10)^2 + 1/(1+0.10)^3 + 1/(1+0.10)^4
PVF = 0.909 + 0.826 + 0.751 + 0.683
PVF = 3.169

Current value = $2,000 x 3.169 = $6,338.76
Tax benefit = $6,338.76 x 40% = $2,535.92

Therefore, the answer is C.

Question 17

Sunk costs are monies that:

Accepted Answer

Sunk costs refer to monies that have already been spent and cannot be recovered, regardless of future decisions or actions. They are not related to future expenses (choice A), recapturing costs (choice C), or future value of an annuity (choice D).

Question 18

A piece of machinery cost $50,000.00 when purchased and has been depreciated half of its value. Assuming the machinery can be sold for $30,000.00, how much accounting profit does the machinery generate?

Accepted Answer

The machinery was depreciated to half of its original value, so its book value is $25,000.00 ($50,000.00 / 2). Selling it for $30,000.00 generates an accounting profit of $5,000.00 ($30,000.00 - $25,000.00).

Question 19

A new project will increase inventory and accounts receivable by an average of $1 million each. Cash levels and other working capital accounts are expected to not change. What effect will the project have on working capital?

Accepted Answer

The project increases both inventory and accounts receivable by $1 million each, totaling a $2 million increase in current assets without affecting other working capital accounts, thus increasing working capital by $2 million.

Question 20

In proper capital budgeting analysis we evaluate incremental _____ cash flows.

Accepted Answer

In proper capital budgeting analysis, we evaluate incremental operating cash flows, which are the additional cash flows generated by a project or investment. This includes revenue generated from sales, as well as any additional operating expenses or costs associated with the project. Accounting cash flows may not capture all relevant expenses or revenue, while before-tax cash flows do not take into account the tax implications of the project. Financing cash flows are not directly related to the operations of the project or investment.

Quiz 11: Cash Flow Estimation