Exam 12: Cash Flow Estimation and Risk Analysis

The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher,other things held constant.

TexMex Food Company is considering a new salsa whose data are shown below.The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value,and no change in net operating working capital would be required.Revenues and other operating costs are expected to be constant over the project's 3-year life.However,this project would compete with other TexMex products and would reduce their pre-tax annual cash flows.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\% Pre-tax cash flow reduction for other products (cannibalization) -\ 5,000 Investment cost (depreciable basis) \ 80,000 Straight-line depr. rate 33.333\% Annual sales revenues \ 66,000 Annual operating costs (excl. depr.) -\ 25,000 Tax rate 35.0\% ?

Estimating project cash flows is generally the most important,but also the most difficult,step in the capital budgeting process.Methodology,such as the use of NPV versus IRR,is important,but less so than obtaining a reasonably accurate estimate of projects' cash flows.

The change in net operating working capital associated with new projects is always positive,because new projects mean that more operating working capital will be required.

Which of the following statements is CORRECT?

Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward,thus increasing their present value.On the other hand,using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses.However,the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.

Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.

Which of the following statements is CORRECT?

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

Which of the following statements is CORRECT?

Carlyle Inc.is considering two mutually exclusive projects.Both require an initial investment of $14,200 at t = 0.Project S has an expected life of 2 years with after-tax cash inflows of $7,400 and $13,600 at the end of Years 1 and 2,respectively.In addition,Project S can be repeated at the end of Year 2 with no changes in its cash flows.Project L has an expected life of 4 years with after-tax cash inflows of $6,000 at the end of each of the next 4 years.Each project has a WACC of 9%.What is the equivalent annual annuity of the most profitable project? Do not round your intermediate calculations.

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

Florida Car Wash is considering a new project whose data are shown below.The equipment to be used has a 3-year tax life,would be depreciated on a straight-line basis over the project's 3-year life,and would have a zero salvage value after Year 3.No change in net operating working capital would be required.Revenues and other operating costs will be constant over the project's life,and this is just one of the firm's many projects,so any losses on it can be used to offset profits in other units.If the number of cars washed declined by 40% from the expected level,by how much would the project's NPV change? (Hint: Note that cash flows are constant at the Year 1 level,whatever that level is. )Do not round the intermediate calculations and round the final answer to the nearest whole number. ? WACC 10.0\% Net investment cost (depreciable basis) \ 60,000 Number of cars washed 2,960 Average price per car \ 25.00 Fixed op. cost (excl. depr.) \ 10,000 Variable op. costiunit (1.e., VC per car washed) \ 5.375 Annual depreciation \ 20,000 Tax rate 35.0\% ?

Desai 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.What is the project's expected NPV? Do not round the intermediate calculations and round the final answer to the nearest whole number. WACC 10.0\% Net investment cost (depreciable basis) \ 200,000 Units sold 39,000 Average price per unit, Year 1 \ 25.00 Fixed op. cost exd. depr. (constant) \ 150,000 Variable op. cost'init, Year 1 \ 20.20 Annual depreciation rate 33.333\% Expected inflation rate per year 5.00\% Tax rate 40.0\% ?

If an investment project would make use of land which the firm currently owns,the project should be charged with the opportunity cost of the land.

Liberty Services is now at the end of the final year of a project.The equipment originally cost $26,500,of which 75% has been depreciated.The firm can sell the used equipment today for $6,000,and its tax rate is 40%.What is the equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value is less than its book value,the firm will receive a tax credit as a result of the sale.

A company is considering a new project.The CFO plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e. ,the initial investment cost,the annual operating cash flows,and the terminal cash flows),then discounting those cash flows at the company's overall WACC.Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

When evaluating a new project,firms should include in the projected cash flows all of the following EXCEPT:

You work for Whittenerg Inc. ,which is considering a new project whose data are shown below.What is the project's Year 1 cash flow? Sales revenues, each year \ 67,000 Depreciation \ 8,000 Other operating costs \ 25,000 Interest expense \ 8,000 Tax rate 35.0\% ?

Changes in net operating working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets,not working capital.