Exam 9: Using Discounted Cash Flow Analysis to Make Investment Decisions

What is the NPV of a project that costs $100,000, provides $23,000 in cash flows annually for six years, requires a $5,000 increase in net working capital, and depreciates the asset straight line over six years while ignoring the half-year convention? The discount rate is 14%.

If a project permits a reduction in the level of working capital, this reduction is assumed to increase cash flows.

Upon the sale of equipment at the end of its useful life, tax liability will be incurred whenever the book value of the equipment exceeds the sales price.

For a profitable firm in the 30% marginal tax bracket with $100,000 of annual depreciation expense, the depreciation tax shield would be:

Class 45 asset purchased for $68,000 at the start of Year 1; Sold at the end of year 3 for $4,000.Analyze what will transpire at the end of year 3.

In what manner does depreciation expense affect investment projects?

Opportunity costs are evaluated for investment decisions at their historical (that is, book) cost.

Although the rule seems very straightforward, why is it stated that financial managers often make the mistake of discounting real cash flows with nominal rates? Mention one common example, and state the effect that this has on project evaluation.

What is the undiscounted cash flow in the final year of an investment, assuming: 10,000 after-tax cash flows from operations, the fully depreciated machine, the sole asset in the pool, is sold for $1,000, the project had required $2,000 in additional working capital, and a 35 percent tax rate?

Determine the change in net working capital that appears warranted for the following proposed project: Inventory levels will increase 20% from their current value of $500,000; cash will increase by $25,000; wage accruals will increase by $60,000; machinery will increase by $75,000; accounts receivable-because of a new collection system-will increase by only $15,000; accounts payable will increase by $45,000.What happens to net working capital at the end of the project's life?

How do changes in working capital affect project cash flows?

What is the amount of the annual depreciation tax shield for a firm with $200,000 in net income, $75,000 in depreciation expense and a 35 percent marginal tax rate?

Higher depreciation rates:

When the real rate of interest is less than the nominal rate of interest, then:

Which of the following statements is correct?

Assume that sales revenues are increasing more rapidly than product costs, but that a project's cash flows have been represented as an annuity when calculating NPV.Which of the following problems may occur?

Allocations of overhead should not affect a project's incremental cash flows unless the:

The statement "We've got too much invested in that project to pull out now" possibly illustrates the need to:

The likely effect of discounting nominal cash flows with real interest rates will be to:

Adding depreciation expense to net profit equals: