Exam 12: Cash Flow Estimation and Risk Analysis

Poulsen Industries is analyzing an average-risk project,and the following data have been developed.Unit sales will be constant,but the sales price should increase with inflation.Fixed costs will also be constant,but variable costs should rise with inflation.The project should last for 3 years,it will be depreciated on a straight-line basis,and there will be no salvage value.No change in net operating working capital would be required.This is just one of many projects for the firm,so any losses on this project can be used to offset gains on other firm projects.The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate,but the CFO thinks an inflation adjustment is required.What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0\% Net investment cost (depreciable basis) \ 201,400 Units sold 48,200 Average price per unit, Year 1 \ 28.50 Fixed op. cost excl. depr. (constant) \ 153,000 Variable op. costiunit, Year 1 \ 20.40 Annual depreciation rate 33.333\% Expected inflation 4.00\% Tax rate 40.0\% ?

We can identify the cash costs and cash inflows to a company that will result from a project.These could be called "direct inflows and outflows," and the net difference is the direct net cash flow.If there are other costs and benefits that do not flow from or to the firm,but to other parties,these are called externalities,and they need not be considered as a part of the capital budgeting analysis.

Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.

Your company,RMU Inc. ,is considering a new project whose data are shown below.What is the project's Year 1 cash flow? Sales revenues \ 23,250 Depreciation \ 8,000 Other operating costs \ 12,000 Tax rate 35.0\% ?

Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books.The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.

Other things held constant,which of the following would increase the NPV of a project being considered?

A company is considering a proposed new plant that would increase productive capacity.Which of the following statements is CORRECT?

Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate,projects' initial outlays and subsequent costs can be forecasted with great accuracy.This is especially true for large product development projects.

Which of the following statements is CORRECT?

Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different lives,it is not used in practice because not projects meet the assumptions the method requires.

Clemson Software is considering a new project whose data are shown below.The required equipment has a 3-year tax life,after which it will be worthless,and it will be depreciated by the straight-line method over 3 years.Revenues and other operating costs are expected to be constant over the project's 3-year life.What is the project's Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number. Equipment cost (depreciable basis) \ 97,000 Straight-line depreciation rate 33.333\% Sales revenues, each year \ 60,000 Operating costs (excl. depr.) \ 25,000 Tax rate 35.0\% ?

Atlas Corp.is considering two mutually exclusive projects.Both require an initial investment of $11,500 at t = 0.Project S has an expected life of 2 years with after-tax cash inflows of $5,800 and $7,700 at the end of Years 1 and 2,respectively.Project L has an expected life of 4 years with after-tax cash inflows of $4,136 at the end of each of the next 4 years.Each project has a WACC of 9.25%,and Project S can be repeated with no changes in its cash flows.The controller prefers Project S,but the CFO prefers Project L.How much value will the firm gain or lose if Project L is selected over Project S,i.e. ,what is the value of NPV_L - NPV_S?

Sub-Prime Loan Company is thinking of opening a new office,and the key data are shown below.The company owns the building that would be used,and it could sell it for $100,000 after taxes if it decides not to open the new office.The equipment for the project would be depreciated by the straight-line method over the project's 3-year life,after which it would be worth nothing and thus it would have a zero salvage value.No change in net operating working capital would be required,and revenues and other operating costs would be constant over the project's 3-year life.What is the project's NPV? (Hint: Cash flows are constant in Years 1-3. )Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0\% Opportunity cost \ 100,000 Net equipment cost (depreciable basis) \ 65,000 Straight-line depr. rate for equipment 33.333\% Annual sales revenues \ 128,000 Annual operating costs (excl. depr.) \ 25,000 Tax rate 35\% ?

Which of the following statements is CORRECT?

The two cardinal rules that financial analysts should follow to avoid errors are: (1)in the NPV equation,the numerator should use income calculated in accordance with generally accepted accounting principles,and (2)all incremental cash flows should be considered when making accept/reject decisions for capital budgeting projects.

If debt is to be used to finance a project,then when cash flows for a project are estimated,interest payments should be included in the analysis.

The two methods discussed in the text for dealing with unequal project lives are (1)the replacement chain approach and (2)the equivalent annual annuity (EAA)approach.

Since the focus of capital budgeting is on cash flows rather than on net income,changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.

As a member of UA Corporation's financial staff,you must estimate the Year 1 cash flow for a proposed project with the following data.What is the Year 1 cash flow? Do not round the intermediate calculations and round the final answer to the nearest whole number. Sales revenues, each year \ 36,750 Depreciation \ 10,000 Other operating costs \ 17,000 Interest expense \ 4,000 Tax rate 35.0\% ?

Which of the following statements is CORRECT?