Question 1

In an equipment selection capital budgeting decision, which of the following will increase the present value of the tax savings from the annual depreciation deductions?

Accepted Answer

An increase in the tax rate will increase the annual tax savings, and therefore increase the present value of those tax savings. Option A is incorrect because an increase in the cost of capital would decrease the present value of the tax savings. Option C is incorrect because an increase in the salvage value would increase the depreciable basis of the equipment, resulting in lower annual depreciation deductions and therefore lower tax savings. Option D is also incorrect because a decrease in the cost of new equipment would not directly affect the tax savings from annual depreciation deductions.

Question 2

A company needs an increase in working capital of $10,000 in a project that will last 4 years. The company's tax rate is 30% and its discount rate is 8%. The present value of the release of the working capital at the end of the project is closest to:

Accepted Answer

A

Question 3

Suppose a machine costs $20,000 now, has an expected life of eight years, and will require a $7,000 overhaul at the end of the third year. If the tax rate is 40%, then the after-tax cost of this overhaul would be:

Accepted Answer

B

Question 4

Last year the sales at Jersey Company were $200,000 and were all cash sales. The expenses at Jersey were $125,000 and were all cash expenses. The tax rate was 30%. The after-tax net cash inflow at Jersey last year from these operations was:

Accepted Answer

The answer of Last year the sales at Jersey Company...

Question 5

Ring Corporation uses a discount rate of 12% and has a tax rate of 30%. The following cash flows occur in the third year of an equipment selection investment project:  The total after-tax present value of the cash flows is closest to:

Accepted Answer

To calculate the after-tax present value of the cash flows, we need to first calculate the after-tax cash flows for each year.

For year 3:
Revenue = $60,000
Less: Expenses = $20,000
Less: Depreciation = $25,000/5 =$5,000
Pre-tax income = $35,000
Taxes (30%) = $10,500
After-tax cash flow = $24,500

Next, we discount this cash flow back to present value using the discount rate of 12%:
PV = $24,500 / (1+0.12)^3
PV = $17,774

Thus, the total after-tax present value of the cash flows is the sum of the present values of each year's after-tax cash flow:
Total PV = $17,774 + $29,461 + $13,000
Total PV = $60,235
Therefore, the best choice is C.

Question 6

Last year the sales at Seidelman Company were $700,000 and were all cash sales. The company's expenses were $450,000 and were all cash expenses. The tax rate was 35%. The after-tax net cash inflow at Seidelman last year was:

Accepted Answer

The net income before taxes can be calculated as:
Sales - Expenses = $700,000 - $450,000 = $250,000
The taxes can be calculated as:
Taxes = Net Income x Tax Rate = $250,000 x 0.35 = $87,500
The after-tax net cash inflow can be calculated as:
Sales - Expenses - Taxes = $700,000 - $450,000 - $87,500 = $162,500

Question 7

A company anticipates a taxable cash receipt of $30,000 in year 2 of a project. The company's tax rate is 30% and its discount rate is 10%. The present value of this future cash flow is closest to:

Accepted Answer

PV = FV / (1+r)^n 
= 30,000 / (1+0.10)^2 
= 30,000 / 1.21 
= $24,793.39

Taxable amount = $24,793.39 x 0.3 = $7,438.02

Therefore, the present value of the taxable cash receipt is closest to $17,355 (Option A) after subtracting the taxes payable.

Question 8

The Dill and Gherkin Law Firm is contemplating the decision to open up a branch office across town. The firm would sign a 5-year lease for a fully furnished office for $24,000 per year. The lease also requires a $30,000 security deposit upon signing. This deposit will be given back at the end of the 5-year lease term. No other amounts will need to be invested. However, additional operating costs are expected to be $65,000 per year for the 5 years. The firm expects to generate an additional $100,000 of revenue per year for the 5 years from the branch office. The firm's after-tax cost of capital is 16% and its tax rate is 30%. The net present value of this investment project is closest to:

Accepted Answer

First, we need to calculate the total cash outflow at the beginning of the project, which is the security deposit plus the first year's lease payment:
$30,000 + $24,000 = $54,000

Next, we need to calculate the net annual cash inflows for the project, which is the additional revenue minus the additional operating costs:
$100,000 - $65,000 = $35,000

We can use the net present value formula to calculate the project's value:
NPV = (Cash inflows / (1 + Cost of capital)^Year) - Cash outflows

NPV = ($35,000 / (1 + 0.16)^1) + ($35,000 / (1 + 0.16)^2) + ($35,000 / (1 + 0.16)^3) + ($35,000 / (1 + 0.16)^4) + ($35,000 / (1 + 0.16)^5) - $54,000

NPV = $30,172.70 + $26,067.60 + $22,327.97 + $18,913.43 + $15,788.43 - $54,000

NPV = $58,269.13 - $54,000

NPV = $4,269.13

Since the net present value is positive, the investment should be undertaken. Choice C is the closest answer at $9,490.

Question 9

A company anticipates a depreciation deduction of $20,000 in year 3 of a project. The company's tax rate is 30% and its discount rate is 14%. The present value of the annual depreciation deductions resulting from this deduction is closest to:

Accepted Answer

The answer of A company anticipates a depreciation deduction of...

Question 10

The reduction in taxes made possible by the annual depreciation deductions equals the depreciation deduction multiplied by the tax rate.

Accepted Answer

This statement is true. The reduction in taxes is equal to the depreciation deduction multiplied by the tax rate because the depreciation deduction lowers taxable income, which in turn lowers the amount of taxes owed.

Question 11

When computing the net present value of the project, what are the annual after-tax cash receipts?

Accepted Answer

The answer of When computing the net present value of...

Question 12

Depreciation expense reduces income taxes by an amount equal to:

Accepted Answer

Depreciation expense is tax deductible, and the tax savings from depreciation is equal to the tax rate multiplied by the amount of depreciation. Therefore, the correct choice is B.

Question 13

Not all cash inflows are taxable.

Accepted Answer

Certain cash inflows, such as gifts, inheritances, and insurance proceeds, are not subject to taxation.

Question 14

The release of working capital at the end of an investment project is a taxable cash inflow.

Accepted Answer

The answer of The release of working capital at the...

Question 15

Superstrut is considering replacing an old press that cost $80,000 six years ago with a new one that would cost $245,000. The old press has a net book value of $15,000 and could be sold for $5,000. The increased production of the new press would require an investment in additional working capital of $6,000. The company's tax rate is 40%. Superstrut's net investment now in the project would be:

Accepted Answer

The answer of Superstrut is considering replacing an old press...

Question 16

When a company invests in equipment, it gets to immediately expense the cost of the equipment on the company's tax reports.

Accepted Answer

When a company invests in equipment, they cannot immediately expense the full cost of the equipment on their tax reports. Instead, they must depreciate the equipment over a period of years based on its useful life. This depreciation expense is then deducted from the company's taxable income each year.

Question 17

The after-tax cost of a deductible cash expense is:

Accepted Answer

The after-tax cost of a deductible cash expense is the amount of the cash expense reduced by the tax savings. The tax savings are the amount of the cash expense times the tax rate, so the after-tax cost is the amount of the cash expense times 1 minus the tax rate. Therefore, choice C is correct.

Question 18

Last year the sales at Summit Company were $400,000 and were all cash sales. The expenses at Summit were $250,000 and were all cash expenses. The tax rate was 40%. The after-tax net cash inflow at Summit last year was:

Accepted Answer

The before-tax net cash inflow for Summit Company would be:
$400,000 (sales) - $250,000 (expenses) = $150,000

The tax on this before-tax net inflow would be:
$150,000 * 0.40 (tax rate) = $60,000

So the after-tax net cash inflow for Summit Company would be:
$150,000 (before-tax net inflow) - $60,000 (taxes) = $90,000

Therefore, the correct choice is C.

Question 19

Consider a machine which costs $115,000 now and which has a useful life of seven years. This machine will require a major overhaul at the end of the fourth year which will cost "X" dollars. If the tax rate is 40%, and if the after-tax cash outflow for this overhaul is $3,600, then the amount of "X" in dollars is:

Accepted Answer

After-tax cost = (1 - Tax rate)F1F1F1S1F1F1F10 Tax-deductible cash expense
$3,600 = (1 - 0.40)F1F1F1S1F1F1F10 Tax-deductible cash expense
Tax deductible cash expense = $3,600 F1F1F1S1F1F1F10 0.60 = $6,000

Question 20

A company anticipates a taxable cash expense of $80,000 in year 2 of a project. The company's tax rate is 30% and its discount rate is 10%. The present value of this future cash flow is closest to:

Accepted Answer

The answer of A company anticipates a taxable cash expense...

Quiz 9: Capital Budgeting Decisions