Deck 11: Capital Budgeting Cash Flows and Risk Refinements

Question 1

Opportunity costs should be included as cash cash flows when determining a project's incremental cash flows.

Answer 1

True

Question 2

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

Answer 2

False

Question 3

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.

Answer 3

True

Question 4

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.

Question 5

Relevant cash flows are the incremental cash outflows and inflows associated with a proposed capital expenditure.

Question 6

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.

Question 7

Cash flows that could be realized from the best alternative use of an owned asset are called

A) incremental costs.
B) lost resale opportunities.
C) opportunity costs.
D) sunk costs.

Question 8

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

A) all cash flows from the old assets are equal.
B) prior cash flows are irrelevant.
C) all cash flows from the old asset are zero.
D) cash inflows equal cash outflows.

Question 9

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

Question 10

Should financing costs such as the returns paid to bondholders and stockholders be considered in computing after tax operating cash flows? Why or why not?

Question 11

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.

Question 12

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

Question 13

The relevant cash flows for a proposed capital expenditure are the incremental after-tax cash outflows and resulting subsequent inflows.

Question 14

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.

A) conventional
B) non-conventional
C) incremental
D) initial

Question 15

Relevant cash flows for a project are best described as

A) incidental cash flows.
B) incremental cash flows.
C) sunk cash flows.
D) accounting cash flows.

Question 16

Cash outlays that had been previously made and have no effect on the cash flows relevant to a current decision are called

A) incremental historical costs.
B) incremental past expenses.
C) opportunity costs foregone.
D) sunk costs.

Question 17

Incremental cash flows represent the additional cash flows expected as a direct result of the proposed project.

Question 18

Initial cash flows and subsequent operating cash flows for a project are sometimes referred to as

A) necessary cash flows.
B) relevant cash flows.
C) consistent cash flows.
D) ordinary cash flows.

Question 19

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

Question 20

Please explain the difference between a sunk cost and an opportunity cost and give an example of each type of cost

Question 21

The basic cash flows that must be considered when determining the initial investment associated with a capital expenditure are the installed cost of the new asset, the after-tax proceeds (if any) from the sale of an old asset, and the change (if any) in net working capital.

Question 22

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.

Question 23

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

A) incremental annual savings produced by the new asset.
B) cost of the new asset.
C) proceeds from the sale of the existing asset.
D) taxes on the sale of an existing asset.

Question 24

If accounts receivable increase by $1,000,000, inventory decreases by $500,000, and accounts payable increase by $500,000, net working capital would

A) decrease by $500,000.
B) increase by $1,500,000.
C) increase by $2,000,000.
D) experience no change.

Question 25

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) an increase of $10,000.
B) a decrease of $10,000.
C) a decrease of $90,000.
D) an increase of $80,000.

Question 26

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 $20,000, accounts receivable by $40,000, and inventories by $60,000. At the same time accounts payable will increase by $50,000, accruals by $10,000, and long-term debt by $100,000. The change in net working capital is

A) an increase of $120,000.
B) a decrease of $40,000.
C) a decrease of $120,000.
D) an increase of $60,000.

Question 27

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

A) the operating cash inflows.
B) the initial investment.
C) the incremental operating cash inflows.
D) the operating cash outflows.

Question 28

Capital gain is the portion of the sale price that is in excess of the initial purchase price.

Question 29

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.

Question 30

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.

Question 31

The book value of an asset is equal to its depreciable value minus the accumulated depreciation.

Question 32

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

A) the change in current liabilities minus the change in current assets.
B) the increase in current assets.
C) the increase in current liabilities.
D) the change in current assets minus the change in current liabilities.

Question 33

Recaptured depreciation is the portion of the sale price that is below book value and has not been depreciated.

Question 34

In evaluating the initial investment for a capital budgeting project,

A) an increase in net working capital is considered a cash inflow.
B) a decrease in net working capital is considered a cash outflow.
C) an increase in net working capital is considered a cash outflow.
D) net working capital does not have to be considered.

Question 35

To calculate the initial investment, we subtract all cash inflows occurring at time zero from all cash outflows occurring at time zero.

Question 36

All of the following would be used in the computation of an investment's initial investment EXCEPT

A) the annual after tax inflow expected from the investment.
B) the initial purchase price of the investment.
C) the resale value of an old asset being replaced.
D) the tax on the sale of an old asset being replaced.

Question 37

Under MACRS depreciation, the depreciable value of an asset is equal to the asset's purchase price minus any installation costs.

Question 38

An important cash inflow in the analysis of initial cash flows for a replacement project is

A) taxes.
B) the cost of the new asset.
C) installation cost.
D) the sale value of the old asset.

Question 39

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

Question 40

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

Question 41

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

A) $0 tax liability.
B) $1,320 tax liability.
C) $1,160 tax liability.
D) $2,000 tax benefit.

Question 42

Compute the initial purchase price for an asset with book value of $34,800 and total accumulated depreciation of $85,200.

Question 43

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

A) an ordinary tax benefit.
B) no tax benefit or liability.
C) recaptured depreciation taxed as ordinary income.
D) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

Question 44

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

A) an ordinary tax benefit.
B) no tax benefit or liability.
C) recaptured depreciation taxed as ordinary income.
D) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

Question 45

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

Question 46

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

A) an ordinary tax benefit.
B) a capital loss tax benefit.
C) recaptured depreciation taxed as ordinary income.
D) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

Question 47

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) $48,560
B) $44,360
C) $49,240
D) $27,600

Question 48

A corporation is selling an existing asset for $1,000. 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

A) $0 tax liability.
B) $1,100 tax liability.
C) $3,600 tax liability.
D) $280 tax benefit.

Question 49

If an asset is sold for book value, the gain on the sale is composed of two parts: a capital gain and recaptured depreciation.

Question 50

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.

Question 51

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.

Question 52

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

A) a capital gain.
B) recaptured depreciation.
C) a capital loss.
D) book value.

Question 53

The book value of an asset is equal to the

A) fair market value minus the accounting value.
B) original purchase price minus annual depreciation expense.
C) original purchase price minus accumulated depreciation.
D) depreciated value plus recaptured depreciation.

Question 54

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

A) $0 tax liability.
B) $7,560 tax liability.
C) $4,400 tax liability.
D) $7,720 tax liability.

Question 55

A corporation is selling an existing asset for $1,700. 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

A) $0 tax liability.
B) $840 tax liability.
C) $3,160 tax liability.
D) $3,160 tax benefit.

Question 56

A corporation has decided to replace an existing asset with a newer model. Two years ago, the existing asset originally cost $30,000 and was being depreciated under MACRS using a five-year recovery period. The existing asset can be sold for $25,000. The new asset will cost $75,000 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) $42,000
B) $52,440
C) $54,240
D) $50,000

Question 57

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

A) a capital gain.
B) recaptured depreciation.
C) a capital loss.
D) book value.

Question 58

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

A) an ordinary tax benefit.
B) a capital gain tax liability.
C) recaptured depreciation taxed as ordinary income.
D) a capital gain tax liability and recaptured depreciation taxed as ordinary income.

Question 59

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.

Question 60

A loss on the sale of an asset that is depreciable and used in business is ________; a loss on the sale of a non-depreciable asset is ________.

A) deductible from capital gains income; deductible from ordinary income
B) deductible from ordinary income; deductible only against capital gains
C) a credit against the tax liability; not deductible
D) not deductible; deductible only against capital gains

Question 61

Table 11.4
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 11.4)

A) $12,000 tax liability
B) $14,560 tax liability
C) $25,280 tax liability
D) $16,600 tax liability

Question 62

Table 11.4
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 cash flow pattern for the replacement project is ________. (See Table 11.4)

A) a mixed stream and conventional
B) a mixed stream and non-conventional
C) an annuity and conventional
D) an annuity and non-conventional

Question 63

Table 11.4
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 1, the cash flow pattern for the expansion project is ________. (See Table 11.4)

A) a mixed stream and conventional
B) a mixed stream and non-conventional
C) an annuity and conventional
D) an annuity and non-conventional

Question 64

Table 11.4
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 1, the initial outlay equals ________. (See Table 11.4)

A) $1,380,000
B) $1,440,000
C) $1,500,000
D) $1,620,000

Question 65

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

Question 66

Table 11.3

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 book value of the existing press being replaced. (See Table 11.3)

Question 67

Table 11.4
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 book value of the existing asset is ________. (See Table 11.4)

A) $13,600
B) $34,400
C) $66,400
D) $80,000

Question 68

In computing after-tax operating cash flows, both operating costs and financing costs must be deducted from any cash inflows received.

Question 69

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.

Question 70

Table 11.4
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 initial outlay equals ________. (See Table 11.4)

A) $120,720 cash outflow
B) $164,560 cash outflow
C) $150,000 cash outflow
D) $167,520 cash outflow

Question 71

In evaluating a proposed project, incremental operating cash inflows are relevant cash flows.

Question 72

An asset was purchased three years ago for $100,000 and can be sold for $40,000 today. The asset 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.

Question 73

Table 11.3

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 11.3)

Question 74

One basic technique used to evaluate after-tax operating cash flows is to

A) add noncash charges to net income.
B) subtract depreciation from operating revenues.
C) add cash expenses to net income.
D) subtract cash expenses from noncash charges.

Question 75

Table 11.3

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 11.3)

Question 76

Compute the depreciation values for an asset which costs $55,000 and requires $5,000 in installation costs using MACRS 5-year recovery period.

Question 77

Benefits expected from proposed capital expenditures must be on an after-tax basis because

A) taxes are cash outflows.
B) no benefits may be used by the firm until tax claims are satisfied.
C) there may also be tax benefits to be evaluated.
D) it is common, accepted practice to do so.

Question 78

Table 11.4
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 1, the annual incremental after-tax cash flow from operations for year 1 is ________. (See Table 11.4)

A) $60,000
B) $255,000
C) $300,000
D) $210,000

Question 79

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.

Question 80

Table 11.4
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 1, the depreciation expense for year 1 is ________. (See Table 11.4)

A) $110,400
B) $115,200
C) $150,000
D) $300,000