Exam 11: Capital Budgeting Cash Flows

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 book value of the existing asset is ________. (See Table 11.3)

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 1 is ________. (See Table 11.3)

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 initial investment of the new asset. (See Table 11.1)

If an investment in a new asset results in a change in current liabilities that exceeds the change in current assets, this change in net working capital represents an initial cash outflow.

A corporation is considering expanding operations to meet growing demand. With the capital expansion the current accounts are expected to change. Management expects cash to increase by $10,000, accounts receivable by $20,000, and inventories by $30,000. At the same time accounts payable will increase by $40,000, accruals by $30,000, and long-term debt by $80,000. The change in net working capital is

A corporation is selling an existing asset for $21,000. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period, and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is

The portion of an asset's sale price that is below its book value and below its initial purchase price is called

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)

All benefits expected from a proposed project must be measured on a cash flow basis which may be found by adding any non-cash charges deducted as an expense on the firm's income statement back to net profits after taxes.

The three major cash flow components include the initial investment, operating cash inflows, and terminal cash flows.

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.

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 initial outlay equals ________. (See Table 11.3)

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset originally cost $70,000 and was being depreciated under MACRS using a five-year recovery period. The existing asset can be sold for $30,000. The new asset will cost $80,000 and will also be depreciated under MACRS using a five-year recovery period. If the assumed tax rate is 40 percent on ordinary income and capital gains, the initial investment is

A firm is selling an existing asset for $5,000. The asset, when purchased, cost $10,000, was being depreciated under MACRS using a five-year recovery period and has been depreciated for four full years. If the assumed tax rate is 40 percent on ordinary income and capital gains, the tax effect of this transaction is

If a new asset is being considered as a replacement for an old asset, the relevant cash flows would be found by adding together the expected cash flows still remaining on the old asset to the expected cash flows for new asset.

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

If an asset is depreciable and used in business, any loss on the sale of the asset is deductible only against other capital gains income, not against ordinary income.

The tax treatment regarding the sale of existing assets that are sold for more than the book value but less than the original purchase price results in

Sunk costs are cash outlays that have already been made and therefore have no effect on the cash flows relevant to the current decision. As a result, sunk costs should not be included as relevant in computing a project's incremental cash flows.

The tax treatment regarding the sale of existing assets that are sold for their book value results in