Exam 12: Capital Budgeting: Principles and Techniques

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 internal rate of return for the project is

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 cash flow pattern for the capital investment proposal is

In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by the annual cash inflow.

The basic cash flows that must be considered when determining the initial investment associated with a capital expenditure are the installed cost of the new asset, the after-tax proceeds (if any) from the sale of an old asset, and the change (if any) in net working capital.

If net present value of a project is greater than zero, the firm will earn a return greater than its costof capital. Such a project should enhance the wealth of the firm's owners.

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 5 is____________

A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows: Project: A Project: B Initial End-of-Year Initial End-of-Year Investment Cash Flows Investment Cash Flows \4 0,000 \2 0,000 \9 0,000 \4 0,000 20,000 40,000 20,000 80,000 -If the firm in Figure 12.5 has a required payback of two (2) years, they should

The most common motive for adding fixed assets to the firm is

The major weakness of the payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximization goal.

When evaluating projects using internal rate of return,

In evaluating a proposed project, since our concern is only with how much more or less operating cash will flow into the firm as a result of the proposed project, incremental operating cash inflows are the relevant cash flows.

Opportunity costs should be included as cash outflows when determining a project's incremental cash flows.

The tax treatment regarding the sale of existing assets which are sold for more than the book value and more than the original purchase price 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 present value of the incremental CCA tax shield is___________

To increase its production capacity, a firm is considering 1) to expand its plant, to acquire another company, or to contract with another company for production.These three projects are examples of independent projects.

A corporation is evaluating the relevant cash flows for a capital budgeting decision and mustestimate the terminal cash flow. The proposed machine will be disposed of at the end of its usablelife of five years at an estimated sale price of $15,000. The machine has an original purchase price of$80,000, installation cost of $20,000, and will be depreciated using a 30% CCA rate. The firm has a40 percent tax rate on ordinary income. The terminal cash flow is ___________. Assume the asset pool is closed at the end of the project.

Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. For each investment proposal, the relevant cash flows and other relevant financial data are summarized in the table below. In the case of a replacement decision, the total installed cost of the equipment will be partially offset by the sale of existing equipment. The firm is subject to a 40 percent tax rate. The firm's cost of capital is 15 percent. Proposal Type of Capital 1 2 3 Budgeting Decision Expansion Replacement Replacement Mut Excl Mut Excl Type of Project Independent with 3 with 2 Cost of new asset \ 1,500,000 \ 200,000 \ 300,000 Installation costs \ 0 \ 0 \ 15,000 CCA rate (new asset) 10\% 20\% 20\% Original cost of old asset N/A* \ 80,000 \ 100,000 Purchase date (old asset) N/A 1/1/1997 1/1/2000 Sale proceeds (old asset) N/A \ 50,000 \ 120,000 CCA rate (old asset) N/A 20\% 20\% Annual net profits before depreciation \& taxes (old) N/A \3 0,000 \2 5,000 Annual net profits before depreciation \& taxes (new) \2 50,000 \1 00,000 \1 75,000 $\text { "Not applicable }$ -For Proposal 3, the cash flow pattern for the replacement project is (See Figure 12.3)

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 net present value of the project is__________

In general, projects with similar-sized investments and lower cash inflows in the early years tend to be preferred at higher discount rates.

If a firm has unlimited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria can be implemented.