Exam 11: Capital Budgeting Cash Flows

A mixer was purchased two years ago for $120,000 and can be sold for $125,000 today. The mixer has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gain. (a) Compute recaptured depreciation and capital gain (loss), if any. (b) Find the firm's tax liability.

Initial cash outflows and subsequent operating cash inflows for a project are referred to as ________.

Table 11.5 Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The gluing 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 under MACRS using a five-year recovery schedule 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. Training costs of employees who will operate the new machine will be a one-time cost of $5,000 which should be included in the initial outlay. The new machine will be depreciated under MACRS using a five-year recovery period. 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 project's annual cash flows is ________. (See Table 11.5)

Companies involved in international capital budgeting projects can minimize political risks by structuring the investment as a joint venture and selecting a well-connected local partner.

If an asset is sold for less than its book value, the loss on the sale may be used to offset ordinary operating income provided the asset is used in the business.

Companies involved in international capital budgeting projects can minimize the long-term currency risk by financing the foreign investment at least partly in the local capital markets.

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. 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 on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent. ________________________________________________________ *Not applicable -For Proposal 3, the initial outlay equals ________. (See Table 11.2)

If a new asset is being considered as a replacement for an old asset, the relevant cash flows would be found by adding the operating cash flows from the old asset to the operating cash flows from the new asset.

A machine was purchased two years ago for $120,000 and can be sold for $50,000 today. The machine has been depreciated using the MACRS 5-year recovery period and the firm pays 40 percent taxes on both ordinary income and capital gains. (a) Compute recaptured depreciation and capital gain (loss), if any. (b) Find the firm's tax liability.

Table 11.3 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 will be depreciated using a five-year recovery schedule. The existing equipment, which originally cost $25,000 and will be sold for $10,000, has been depreciated using an MACRS five-year recovery schedule and three years of depreciation has already been taken. 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 for year 5 is ________. (See Table 11.3)

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2014. 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 on ordinary income and on long-term capital gains. The firm's cost of capital is 15 percent. ________________________________________________________ *Not applicable -For Proposal 1, the cash flow pattern for the expansion project is ________. (See Table 11.2)

If an asset is sold for more than its initial purchase price, the gain on the sale is composed of two parts: a capital gain and recaptured depreciation.

In computing after-tax operating cash flows, only operating costs but not financing costs must be deducted from any cash inflows received.

When evaluating a capital budgeting project, installation costs of a new machine must be considered as part of ________.

Table 11.1 Fine Press is considering replacing the existing press with a more efficient press. The new press costs $55,000 and requires $5,000 in installation costs. The old press was purchased 2 years ago for an installed cost of $35,000 and can be sold for $20,000 net of any removal costs today. Both presses are depreciated under the MACRS 5-year recovery schedule. The firm is in 40 percent marginal tax rate. -Calculate the tax effect from the sale of the existing asset. (See Table 11.1)

The change in net working capital-regardless of whether an increase or decrease-is not taxable because it merely involves a net buildup or net reduction of current accounts.

Recaptured depreciation is the portion of the sale price that is in excess of the initial purchase price.

In developing the cash flows for an expansion project, the analysis is the same as the analysis for replacement projects where ________.

Benefits expected from proposed capital expenditures ________.

In case of an existing asset which is depreciable and is used in business and is sold for a price equal to its initial purchase price, the difference between the sales price and its book value is considered as recaptured depreciation and will be taxed as ordinary income.