Question 1

If the new machine is purchased, depreciation expense will increase or decrease by

Accepted Answer

The depreciation expense will increase by the amount of the depreciation expense of the new machine, which is $6,900 (($46,000 - $4,000) / 8 years).

Question 2

It is more common in practice for companies to use cash flows estimated in real dollars discounted at the real rate of interest than to use nominal dollars and the nominal discount rate.

Accepted Answer

Most companies prefer using nominal dollars and the nominal discount rate for cash flow analysis because it includes the effects of inflation, making it easier to estimate future cash flows and financing needs.

Question 3

Taxes may have a significant effect on the cost of replacing an old asset with a new asset.

Accepted Answer

Taxes on the sale of the old asset and on the purchase of the new asset can increase the cost of replacing the old asset with a new one. The tax implications should be taken into consideration when making such a decision.

Question 4

Increased taxes on the sale of the old machine are

Accepted Answer

The increased taxes on the sale of the old machine are $1,487.50, as this is the correct calculation based on the given options.

Question 5

When computing the NPV of a project, if cash flows are discounted at the real cost of capital, then the cash flows should not be adjusted for inflation.

Accepted Answer

Discounting cash flows at the real cost of capital means accounting for inflation in the cost of capital, so adjusting the cash flows for inflation would result in double-counting.

Question 6

The original cost and expected life of old assets are critical considerations in replacement decisions.

Accepted Answer

The answer of The original cost and expected life of...

Question 7

The salvage value of equipment should not be considered when replacing it with new equipment.

Accepted Answer

The salvage value of equipment should be considered when replacing it with new equipment because it can offset the cost of the new equipment and reduce the overall cost of the replacement.

Question 8

When computing the NPV of a project, it is important to consistently use either nominal dollars and nominal rates or real dollars and real rates.

Accepted Answer

NPV calculations require consistency between the dollar values and interest rates used. If nominal values are used for one and real values are used for the other, the resulting NPV will be distorted and inaccurate. It is important to use either all nominal values or all real values in the calculation.

Question 9

What is meant by "real dollars" and the "real" discount rate? How can they be used to account for inflation when evaluating capital budgeting proposals?

Accepted Answer

The answer of What is meant by "real dollars" and...

Question 10

If the new machine is purchased, operating cash flow for years 1 through 5 will increase or decrease by

Accepted Answer

The increase in operating cash flow due to purchasing the new machine can be calculated as follows:
Year 1: Increase in operating cash flow = $12,000 - $10,200 = $1,800
Year 2: Increase in operating cash flow = $12,000 - $9,720 = $2,280
Year 3: Increase in operating cash flow = $12,000 - $9,248 = $2,752
Year 4: Increase in operating cash flow = $12,000 - $8,784 = $3,216
Year 5: Increase in operating cash flow = $12,000 - $8,328 = $3,672
Total increase in operating cash flow for years 1-5 = $1,800 + $2,280 + $2,752 + $3,216 + $3,672 = $12,720
Therefore, the best choice is C, an increase in operating cash flow of $12,246 (rounded to the nearest dollar).

Question 11

Tversky and Co. have devised a new psychological test for investors' risk tolerance. They expect to sell 10,000 tests in the first year at $150 each. Cash costs associated with producing, administering and scoring the test are $50 per unit. In the second year, volume is expected to be the same, but both the price and the costs will increase 2.5%. Forecast gross profit in the second year.

Accepted Answer

The answer of Tversky and Co. have devised a new...

Question 12

Al's Fabrication Shop is purchasing a new rivet machine to replace an existing one. The new machine costs $8,000 and will require an additional cost of $1,000 for modification and training. It will be depreciated using simplified straight line depreciation over five years. The new machine operates much faster than the old machine and with better quality. Consequently, sales are expected to increase by $2,100 per year for the next five years. While it is faster, it is fully automated and will result in increased electricity costs for the firm by $700 per year. It will, however, save about $850 per year in labor costs. The old machine is 20 years old and has already been fully depreciated. If the firm's marginal tax rate is 28%, compute the after tax incremental cash flows for the new machine for years 1 through 5.

Accepted Answer

The after-tax incremental cash flows can be calculated by considering the additional revenue, additional costs, and savings, then adjusting for taxes. The calculation is as follows:- Additional revenue: $2,100 per year- Increased costs: $700 per year for electricity- Savings: $850 per year in labor costs- Depreciation: ($8,000 + $1,000) / 5 years = $1,800 per yearThe net benefit before taxes is $2,100 (additional revenue) - $700 (additional costs) + $850 (savings) = $2,250 per year. Depreciation does not affect cash flow directly but provides a tax shield. The tax shield is $1,800 (depreciation) * 28% (tax rate) = $504.The net benefit after taxes is $2,250 - ($2,250 * 28%) = $2,250 - $630 = $1,620. Adding back the tax shield from depreciation gives $1,620 + $504 = $2,124.

Question 13

Nominal cash flows are expressed in terms of their purchasing power in a base year.

Accepted Answer

Nominal cash flows are expressed in actual dollars received or paid at a specific point in time, without accounting for inflation or changes in purchasing power. It is real cash flows that are adjusted for inflation to reflect their purchasing power in a base year.

Question 14

What would cause the initial cash outlay of an investment decision to be affected by the sale of an existing asset?

Accepted Answer

If the investment decision is a replacement decision, then the sale of an existing asset could affect the initial cash outlay. The sale of the existing asset would generate cash that could be used to offset the cost of the new asset, reducing the initial cash outlay.

Question 15

The relevant depreciation expense for a replacement investment is the difference between depreciation on the new asset(s) and the old asset(s).

Accepted Answer

The relevant depreciation expense for a replacement investment is the difference between depreciation on the new asset(s) and the old asset(s), as the old asset becomes obsolete and is replaced by a newer asset. The difference between the two will determine the net impact on the company's overall depreciation expense.

Question 16

National Geographic is replacing an old printing press with a new one. The old press is being sold for $350,000 and it has a net book value of $75,000. Assume that National Geographic is in the 40% income tax bracket. How much will National Geographic pay in income taxes from the sale?

Accepted Answer

The answer of National Geographic is replacing an old printing...

Question 17

Krugman Construction Company is considering the purchase of a new crane at a cost of $600,000. If the new crane is purchased the old crane will sold. It was purchased 5 years ago at a cost of $450,000. To date, the company has taken $200,000 in depreciation on the old crane. Compute the cash flow that would be realized from selling the old crane under each of the following scenarios. Krugman's marginal tax rate is 30%.
a. The crane is sold for $200,000
b. The crane is sold for $250,000
c. The crane is sold for $300,000

Accepted Answer

The answer of Krugman Construction Company is considering the purchase...

Question 18

When replacing old assets with new assets, it is safe to assume that working capital requirements will remain the same.

Accepted Answer

When replacing old assets with new assets, working capital requirements may change depending on the type of asset being replaced and the new asset being purchased. For example, if the new asset requires higher operating and maintenance costs, then working capital requirements may increase. Similarly, if the new asset has a longer depreciation period, then working capital requirements may decrease. Thus, it is not safe to assume that working capital requirements will remain the same.

Question 19

Greenspan Inc. discounts cash flows at a nominal rate of 10%. Inflation over the next few years is expected to average 3%. Which of the following would be a correct adjustment for inflation when computing net present value?

Accepted Answer

The correct adjustments for inflation when computing net present value can be either to discount cash flows at the nominal rate (which includes inflation) and adjust revenues and expenses for inflation (Option A), or to discount cash flows at the real rate (nominal rate minus inflation rate) and not adjust revenues and expenses for inflation (Option C). Both methods should theoretically yield the same result.

Question 20

The real discount rate includes expected inflation.

Accepted Answer

The real discount rate adjusts the nominal discount rate to remove the effects of inflation, representing the true cost of capital excluding inflation.

Quiz 12: Analyzing Project Cash Flows