Exam 11: Capital Budgeting Cash Flows

When making replacement decisions, the development of relevant cash flows is complicated when compared to expansion decisions, due to the need to calculate ________ cash inflows.

Table 11.4 Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given. The firm pays 40 percent taxes on ordinary income and capital gains. -Given the information in Table 11.4, compute the incremental annual cash flows.

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

Relevant cash flows for a project are best described as

Accounting figures and cash flows are not necessarily the same due to the presence of certain non-cash expenditures on the firm's income statement.

In evaluating the initial investment for a capital budgeting project,

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 internal rate of return for the project is ________. (See Table 11.5)

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. 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 2, the tax effect on the sale of the existing asset results in ________. (See Table 11.2)

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 cash flow pattern for the capital investment proposal is ________. (See Table 11.3)

A sunk cost is a cash flow that could be realized from the best alternative use of an owned asset.

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. 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 incremental depreciation expense for year 3 is ________. (See Table 11.2)

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.

The book value of an asset is equal to the

When evaluating a capital budgeting project, the change in net working capital must be considered as part of

The change in net working capital when evaluating a capital budgeting decision is

A sunk cost is a cash outlay that has already been made and therefore has no effect on the cash flows relevant to a current decision.

Table 11.2 Computer Disk Duplicators, Inc. has been considering several capital investment proposals for the year beginning in 2004. 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 cash flow pattern for the replacement project is ________. (See Table 11.2)

The basic variables that must be considered in determining the initial investment associated with a capital expenditure are all of the following EXCEPT

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 11.3 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 tax effect on the sale of the existing asset results in ________. (See Table 11.3)