Deck 6: Capital Budgeting Process and Decision Criteria and Cash Flow and Capital Budgeting

Question 1

A firm is evaluating two machines. Both machines meet the firm's quality standard. Machine A costs $40,000 initially and $1,000 per year to maintain. Machine B costs $24,000 initially and $2,000 per year to maintain. Machine A has a 6-year useful life and machine B has a 3-year useful life. Both machines have zero salvage value. Assume the firm will continue to replace worn-out machines with similar machines, and the discount rate is 7%. Which machine should the firm purchase?

A) Machine A
B) Machine B
C) The firm is indifferent to the two machines
D) Can't tell from the given information

Answer 1

Machine A

Question 2

You are given the following information. What is the initial cash outflow?

A) $9,400
B) $9,000
C) $13,000
D) $10,600

Answer 2

$9,400

Question 3

Johnson Chemicals is considering an investment project. The project requires an initial $3 million outlay for equipment and machinery. Sales are projected to be $1.5 million per year for the next four years. The equipment will be fully depreciated straight-line by the end of year 4. Cost of goods sold and operating expense (not including depreciation) are predicted to be 30% of sales. The equipment can be sold for $400,000 at the end of year 4. Johnson Chemicals also needs to add net working capital of $100,000 immediately. The net working capital will be recovered in full at the end of the fourth year. Assume the tax rate is 40% and the cost of capital is 10%.
What is the NPV of this investment?

A) $89,290
B) $80,199
C) $189,482
D) $72,909

Answer 3

$80,199

Question 4

Which of the following items will lead to a rise in net working capital?
A. Raw materials are purchased prior to the sale of finished goods
B. The firm increases its cash balance
C. The firm makes a sale on credit
D. The firm buys inventory on credit
E.Short-term interest rates fall

A) A,B,C
B) A,B,D,E
C) A,C
D) A,B,C,D

Question 5

Kelley Group is considering an investment of $2 million in an asset with an economic life of four years. The cash revenues and expenses in year 1 are expected to be $1.8m and $0.5m respectively. Both revenues and expenses are expected to grow at 3 percent per year. The asset will be fully depreciated to zero using the straight line method over its economic life. The salvage value of the asset is expected to be $0.3m at the end of the fourth year. Kelley Group also needs to add net working capital of $0.1m immediately, and this capital will be recovered in full at the end of the project's life. The tax rate is 40%. What is the investment's cash flow in year 4?

A) $1.1323m
B) $1.4523m
C) $1.3323m
D) $1.3579m

Question 6

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the initial investment outlay for this project?

A) $10,000
B) $135,000
C) $145,000
D) $155,000

Question 7

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the depreciation expense in year 1?

A) $44,996
B) $10,004
C) $60,008
D) $19,994

Question 8

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the depreciation expense in year 2?

A) $44,996
B) $10,004
C) $60,008
D) $19,994

Question 9

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the depreciation expense in year 3?

A) $44,996
B) $10,004
C) $60,008
D) $19,994

Question 10

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the operating cash flow for year 1?

A) $54,797
B) $64,798
C) $70,803
D) $10,487

Question 11

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the operating cash flow for year 2?

A) $54,797
B) $64,798
C) $70,803
D) $10,487

Question 12

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the operating cash flow for year 3?

A) $54,797
B) $64,798
C) $70,803
D) $10,487

Question 13

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the NPV of the project?

A) $14.732
B) $12,986
C) $19,983
D) -$19,983

Question 14

DSSS Corporation
DSSS Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $125,000. The cost of shipping and installation is an additional $10,000. The asset will fall into the 3-year MACRS class. The year 1- 4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $225,000 per year. Cost of goods sold will be 60% of sales. The project will require an increase in net working capital of $10,000. At the end of three years, DSSS plans on ending the project and selling the manufacturing equipment for $25,000. The marginal tax rate is 40% and DSSS Corporation's appropriate discount rate is 15%.

-Refer to DSSS Corporation. What is the IRR of the project?

A) 22.79%
B) -10.01%
C) 19.47%
D) 27.36%

Question 15

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the initial investment outlay for this project?

A) $10,000
B) $135,000
C) $145,000
D) $165,000

Question 16

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the depreciation expense in year 1?

A) $49,995
B) $22,215
C) $11,115
D) $66,675

Question 17

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the depreciation expense in year 2?

A) $49,995
B) $22,215
C) $11,115
D) $66,675

Question 18

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the depreciation expense in year 3?

A) $49,995
B) $22,215
C) $11,115
D) $66,675

Question 19

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the book value of the machine at the end of year 3?

A) $44,995
B) $22,215
C) $11,115
D) $66,675

Question 20

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the NPV of the project?

A) $21,597
B) $73,548
C) -$21,597
D) -$52,489

Question 21

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the operating cash flow for year 1?

A) $55,470
B) $60,000
C) $48,798
D) $37,686

Question 22

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the operating cash flow for year 2?

A) $55,470
B) $60,000
C) $48,798
D) $37,686

Question 23

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the operating cash flow for year 3?

A) $55,470
B) $60,000
C) $48,798
D) $37,686

Question 24

FAR Corporation
FAR Corporation is considering a new project to manufacture widgets. The cost of the manufacturing equipment is $150,000. The cost of shipping and installation is an additional $15,000. The asset will fall into the 3-year MACRS class. The year 1-4 MACRS percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively. Sales are expected to be $300,000 per year. Cost of goods sold will be 80% of sales. The project will require an increase in net working capital of $15,000. At the end of three years, FAR plans on ending the project and selling the manufacturing equipment for $35,000. The marginal tax rate is 40% and FAR Corporation's appropriate discount rate is 12%.

-Refer to FAR Corporation. What is the total cash flow generated in year 3?

A) $35,000
B) $9,554
C) $15,000
D) $40,446

Question 25

If Gamma Electronics has a 15% cost of capital, what's the NPV of the investment?

A) $213,745
B) $185,865
C) $713,745
D) $500,000

Question 26

What is the IRR of the proposed Commerce Company project?

A) 7.00%
B) 15.24%
C) 23.29%
D) 42.85%

Question 27

Swerling Company
Swerling Company is considering a project with the following cash flows.


-What is the IRR of the proposed Swerling Company project?

A) 9.57%
B) 8.35%
C) 7.72%
D) 6.91%