Exam 6: Making Investment Decisions With the Net Present Value Rule

A firm owns a building with a book value of $150,000 and a market value of $250,000. If the building is utilized for a project, then the opportunity cost ignoring taxes is:

Two machines, A and B, which perform the same functions, have the following costs and lives. Type PV Costs Life Machine A \ 6000 5 Machine B \ 8000 7 Which machine would you choose? The two machines are mutually exclusive and the cost of capital is 15%.

Proper treatment of inflation in the NPV calculation involves: I. Discounting nominal cash flows using the nominal discount rate II. Discounting real cash flows using the real discount rate III. Discounting nominal cash flows using the real discount rates

Briefly discuss how taxes are taken into consideration in countries like Japan.

RainMan Inc. is in the business of producing rain upon request. They must decide between two investment projects; a new airplane for seeding rain clouds or a new weather control machine built by Dr. Nutzbaum. The discount rate for the new airplane is 9%, while the discount rate for the weather machine is 39% (it happens to be higher risk). Which investment should the company select and why? Year Airplane Weather Machine 0 -900 -900 1 500 550 2 600 600 3 685

If the depreciable investment is $600,000 and the MACRS 5-Year class schedule is: Year-1: 20%; Year-2: 32%; Year-3: 19.2%; Year-4: 11.5%; Year-5: 11.5% and Year-6: 5.8% Calculate the depreciation for Year-2.

The real interest rate is 3% and the inflation rate is 5%. What is the nominal interest rate?

Capital equipment costing $250,000 today has 50,000 salvage value at the end of 5 years. If the straight line depreciation method is used, what is the book value of the equipment at the end of two years?

Working capital is one of the most common sources of mistakes in estimating project cash flows.

For example, in the case of an electric car project, which of the following cash flows should be treated as incremental flows when deciding whether to go ahead with the project?

If the discount rate is stated in real terms, then in order to calculate the NPV in a consistent manner requires that project: I. cash flows be estimated in nominal terms II. cash flows be estimated in real terms III. accounting income be used

When calculating cash flows, it is important to consider them on an incremental basis.

The cost that is incurred as a result of past, irrevocable decisions and is irrelevant to future decisions is called:

Briefly explain how the decision to replace an existing machine is made?

The principal short-term assets are: I. Cash II) Accounts receivable III) Inventories, IV) Accounts Payable

All large U.S. corporations keep two separate sets of books, one for the stockholders and one for the Internal Revenue Service.

A project requires an initial investment of $200,000 and is expected to produce a cash flow before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t = 2]. The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year schedule: (t=1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can make use of all applicable tax shields. The opportunity cost of capital is 11%. Assume that the asset can be sold for book value. Calculate the IRR for the project: (approximately)

If the depreciation amount is $100,000 and the marginal tax rate is 35%, then the tax shield due to depreciation is:

If the depreciation amount is 600,000 and the marginal tax rate is 35%, then the tax shield due to depreciation is:

A project requires an initial investment of $200,000 and is expected to produce a cash flow before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t = 2]. The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year schedule: (t=1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can make use of all applicable tax shields. The opportunity cost of capital is 12%. Assume that the asset can be sold for book value. Calculate the NPV of the project: (Approximately)