Exam 12: Capital Budgeting: Principles and Techniques

Since the payback period can be viewed as a measure of risk exposure, many firms use it as a decision criterion or as a supplement to sophisticated decision techniques.

The tax treatment regarding the sale of existing assets which are depreciable and used in business and are sold for less than the book value results in

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by $17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of capital and a 40 percent tax on ordinary income and capital gains. -The tax effect of the sale of the existing asset is

Nuff Folding Box Company, Inc. is considering purchasing a new glueing machine. The glueing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated using the Class 10 CCA rate of 30% and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by $17,000 per year. The new machine will be depreciated using the Class 10 CCA rate of 30%. The firm has a 12 percent cost of capital and a 40 percent tax on ordinary income and capital gains. -The present value of the project's five-year incremental after-tax operating income is___________

Capital expenditure is an outlay of funds invested only on fixed assets and is expected to produce benefits over a period of time greater than one year.

Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as

A loss on the sale of an asset which is depreciable and used in business is___________ sale of a non-depreciable asset is___________.

The CCA rate for automobiles is higher than the CCA rate for brick buildings.

When evaluating a capital budgeting project, the change in net working capital must be considered as part of

A firm with limited funds must ration its funds by allocating them to projects that will maximize share value.

Capital budgeting technique is used to evaluate the firm's fixed asset investments which provide the basis for the firm's earning power and value.

A non-conventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by a series of inflows.

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate. -The initial outlay equals__________

Cuda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $3,000. The asset is from the same CCA pool as the existing asset and will be depreciated using a 20% CCA rate. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated for three years. The new equipment is expected to result in incremental before-tax net profits of $15,000 per year. The firm has a 40 percent tax rate. -The incremental depreciation expense (CCA) for year 1 is

Conflicting rankings using NPV and IRR result from differences in the magnitude and timing of cash flows.

A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent. Project Initial Investment IRR NPV 1 \ 200,000 19\% \ 100,000 2 400,000 17 20,000 3 250,000 16 60,000 4 200,000 12 -5,000 5 150,000 20 50,000 6 400,000 15 150,000 -Using the net present value approach to ranking projects, which projects should the firm accept? (See Figure 12.6)

When the firm is confronted with a number of projects, some of which are mutually exclusive and some of which are independent, it must first determine the best of each group of mutually exclusive alternatives. The best of the acceptable independent projects can then be selected.

The internal rate of return assumes that intermediate cash inflows are invested at a rate equal to the firm's cost of capital.

Independent projects are projects that compete with one another, so that the acceptance of one eliminates the others from further consideration.

In evaluating the initial investment for a capital budgeting project,