Deck 9: Fundamentals of Capital Budgeting

Question 1

The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.

Answer 1

True

Question 2

Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product?

A)The cost of capital tends to fluctuate over the period in question.
B)The prices of technology products generally fall over time.
C)Competition tends to reduce profit margins over time in most industries.
D)Sales of a new product will typically accelerate, plateau, and ultimately decline over time.

Answer 2

The cost of capital tends to fluctuate over the period in question.

Question 3

An oil company is buying a semi-submersible oil rig for $25 million. Additionally, it will cost $2.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is depreciated over five years using straight-line depreciation, what are the annual depreciation expenses in this case?

A)$5.5 million
B)$5.0 million
C)$4.0 million
D)$5.3 million

Answer 3

$5.0 million

Question 4

How do we handle interest expense when making a capital budgeting decision?

Question 5

Interest and other financing-related expenses are excluded when determining a project's unlevered net income.

Question 6

What is the ultimate goal of the capital budgeting process?

A)To list the projects and investments that a company plans to undertake in the future
B)To determine the effect of the decision to accept or reject a project on the firm's cash flows
C)To forecast the consequences of a list of future projects to the firm
D)To determine how the consequences of making a particular decision affects the firm's revenues and costs

Question 7

What is the correct tax rate that should be used for capital budgeting decisions?

Question 8

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10 000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an 'operating expense'?

A)the cost of the depositor only
B)the delivery and install cost only
C)the cost of the clean room only
D)the delivery and install cost and the cost of the depositor

Question 9

Investments in plant, property and equipment are directly listed as an 'expense' when calculating earnings.

Question 10

When evaluating the effectiveness of an improved manufacturing process, we should evaluate the total sales and costs generated by this process.

Question 11

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $8 million to buy the machine and $25 000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $2 million. The machine is expected to have a working life of five years. If straight-line depreciation is used, what are the annual depreciation expenses in this case?

A)$1 600 000
B)$2 005 000
C)$1 550 000
D)$1 605 000

Question 12

Capital budgeting decisions use the Net Present Value rule so that those decisions maximise net present value (NPV).

Question 13

Vernon-Nelson Chemicals is planning to release a new brand of insecticide, Bee-Safe, that will kill many insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost $20 million and there will be an additional $2 million cost to reconfigure the existing plant. The equipment is expected to have a lifetime of eight years and will be depreciated by the straight-line method over its lifetime. The firm expects that they should be able to sell 1 500 000 litres per year at a price of $52 per litre. It will take $38 per litre to manufacture and support the product. If Vernon-Nelson's marginal tax rate is 30%, what are the incremental earnings in year 3 of this project?

A)$10.53 million
B)$12.65 million
C)$12.95 million
D)$18.54 million

Question 14

To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm's earnings.

Question 15

Only include as 'incremental expenses' in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project.

Question 16

Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?

A)They are not easily predicted from historical financial statements of a firm and its competitors.
B)They do not tell how the decision affects the firm's reported profits from an accounting perspective.
C)They do not show how the firm's earnings are expected to change as the result of a particular decision.
D)These earnings are not actual cash flows.

Question 17

Which of the following best defines 'incremental earnings'?

A)The net present value (NPV)of earnings that a firm is expected to receive as the result of an investment decision
B)The amount by which a firm's earnings are expected to change as the result of an investment decision
C)Cash flows arising from a particular investment decision
D)The earnings arising from all projects that a company plans to undertake in a fixed timespan

Question 18

A capital budget lists the projects and investments that a company plans to undertake during future years.

Question 19

How does the capital budgeting process begin?

A)By analysing alternate projects
B)By forecasting the future consequences for the firm of each potential project
C)By compiling a list of potential projects
D)By evaluating the net present value (NPV)of each project's cash flows

Question 20

The fact that a new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product is a factor that a manager should bear in mind when estimating a project's revenues and costs.

Question 21

Use the table for the question(s)below.
The balance sheet for a small firm is shown above. All amounts are in thousands of dollars. What is this firm's Net Working Capital?

A)$30 000
B)$47 000
C)$40 000
D)$89 000

Question 22

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Which of the following would you NOT consider when making a capital budgeting decision?

A)the change in direct labour expense due to the purchase of a new machine
B)the additional taxes a firm would have to pay in the next year
C)the opportunity to lease out a warehouse instead of using it to house a new production line
D)the cost of a marketing study completed last year

Question 23

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10 000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 30%. What are the incremental free cash flows associated with the new machine in year 1?

A)-$6 000 000
B)$1 001 667
C)-$3 709 417
D)-$6 010 000

Question 24

Use the information for the question(s)below.
Ford Motor Company is considering launching a new line of hybrid diesel-electric 4WDs. The heavy advertising expenses associated with the new 4WD launch would generate operating losses of $40 million next year. Without the new 4WD, Ford expects to earn pre-tax income of $75 million from operations next year. Ford pays a 25% tax rate on its pre-tax income.
The amount that Ford Motor Company owes in taxes next year without the launch of the new 4WD is closest to:

A)$13.55 million
B)$18.75 million
C)$8.75 million
D)$16.75 million

Question 25

A brewer is launching a new product-brewed ginger beer with low alcohol content. The brewer plans to spend $4 million promoting this product this year, which is expected to expand its sales of this product to $10 million this year and $8 million next year. They do expect there will be loss of sales of $1 million this year and next year in their other products as customers switch to drinking the new ginger beer. The gross profit margin for the new ginger beer is 40%, the gross profit margin of all of the brewer's other products is 30%, and the brewer's marginal corporate tax rate is 30%. What are incremental earnings arising from the promotional campaign this year?

A)$4.68 million
B)$3.29 million
C)$5.28 million
D)$2.10 million

Question 26

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Which of the following formulas will correctly calculate Net Working Capital?

A)Cash - Inventory + Receivables + Payables
B)Cash + Inventory + Receivables - Payables
C)Cash + Inventory + Receivables + Payables
D)Cash + Inventory - Receivables + Payables

Question 27

A small manufacturer that makes clothes pegs and other household products buys new injection moulding equipment for a cost of $500 000. This will allow the manufacturer to make more pegs in the same amount of time with an estimated increase in sales of 15%. If the manufacturer currently makes 75 tonnes of pegs per year, which sell at $18 000 per tonne, what will be the increase in revenue next year from the new equipment?

A)$80 500
B)$20 700
C)$202 500
D)$857 000

Question 28

Use the table for the question(s)below.
Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $100 000; however, a commercial real estate agent has informed you that an outside buyer interested in purchasing this land would be willing to pay $650 000 for it. When calculating the net present value (NPV)of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is

A)$100 000.
B)$0.
C)$750 000.
D)$650 000.

Question 29

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Which of the following is an example of 'cannibalisation'?

A)A grocery store begins selling T-shirts featuring the local university's logo.
B)A football manufacturer adds football boots to its product line.
C)A newsagent begins selling prepaid mobile phones.
D)A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda)to its product line.

Question 30

CathFoods will release a new range of lollies which contain antioxidants. New equipment to manufacture the lollies will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new product line. It is expected that the range of lollies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 30%, what are the incremental earnings in the second year of this project?

A)$2.11 million
B)$1.47 million
C)$1.54 million
D)$1.75 million

Question 31

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
The depreciation tax shield for the Sisyphean Corporation's project in the first year is closest to:

A)$2 800
B)$8 000
C)$3 000
D)$5 200

Question 32

A decrease in the sales of a current project because of the launching of a new project is

A)an overhead expense.
B)irrelevant to the investment decision.
C)a sunk cost.
D)cannibalisation.

Question 33

Use the table for the question(s)below.
A firm reports that in a certain year it had a net income of $4.5 million, depreciation expenses of $2.8 million, capital expenditures of $2.3 million, and Net Working Capital decreased by $1.5 million. What is the firm's free cash flow for that year?

A)$6.5 million
B)$11.1 million
C)$8.1 million
D)$2.4 million

Question 34

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?

A)subtracting all non-cash expenses
B)adding depreciation
C)subtracting depreciation expenses from taxable earnings
D)subtracting increases in Net Working Capital

Question 35

Use the information for the question(s)below.
Ford Motor Company is considering launching a new line of hybrid diesel-electric 4WDs. The heavy advertising expenses associated with the new 4WD launch would generate operating losses of $40 million next year. Without the new 4WD, Ford expects to earn pre-tax income of $75 million from operations next year. Ford pays a 25% tax rate on its pre-tax income.
The amount that Ford Motor Company owes in taxes next year with the launch of the new 4WD is closest to:

A)$13.55 million
B)$18.75 million
C)$8.75 million
D)$16.75 million

Question 36

Use the table for the question(s)below.
You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an increase in inventory of $8 000, an increase in accounts payables of $2 500, and an increase in property, plant, and equipment of $40 000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is

A)$6 500.
B)$10 500.
C)$5 500.
D)$45 500.

Question 37

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10 000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 30%. What are the incremental free cash flows associated with the new machine in year 2?

A)$1 001 667
B)$2 400 500
C)$3 247 834
D)$1298 917

Question 38

Which of the following costs would you consider when making a capital budgeting decision?

A)sunk cost
B)fixed overhead cost
C)opportunity cost
D)interest expense

Question 39

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated by the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
CathFoods will release a new range of lollies which contain antioxidants. New equipment to manufacture the lollies will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new line. It is expected that the range of lollies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 30%, what are the incremental free cash flows in the second year of this project?

A)$2.015 million
B)$1.870 million
C)$2.500 million
D)$2.415 million

Question 40

A stationery company plans to launch a new type of permanent marker. Advertising for the new product will be heavy and will cost the company $10 million, although the company expects general revenues of $280 million next year from sources other than sales of the new pen. If the company has a corporate tax rate of 30% on its pre-tax income, what effect will the advertising for the new pen have on its taxes?

A)no effect on taxes
B)increase taxes by $3 million
C)increase taxes by $10 million
D)reduce taxes by $3 million

Question 41

Use the table for the question(s)below.
The Sisyphean Corporation is considering a new project that will have an annual depreciation expense of $2.5 million. If Sisyphean's marginal corporate tax rate is 30%, what is the value of the depreciation tax shield on the company's new project?

A)$1 500 000
B)$750 000
C)$1 000 000
D)$1 750 000

Question 42

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

The free cash flow for the last year of Epiphany's project is closest to:

A)$47 750
B)$62 750
C)$39 000
D)$45 000

Question 43

If a business owner is using the extra space at home for his business, does it imply a zero 'opportunity cost' for the space?

Question 44

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated using the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
Bubba Ho-Tep Ltd reported net income of $360 million for the most recent fiscal year. The firm had depreciation expenses of $150 million and capital expenditures of $180 million. Although it had no interest expense, the firm did have an increase in net working capital of $24 million. What is Bubba Ho-Tep's free cash flow?

A)$306 million
B)$250 million
C)$370 million
D)$5 million

Question 45

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

The net present value (NPV)for Epiphany's Project is closest to:

A)$35 364
B)$39 000
C)$29 400
D)$14 348

Question 46

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1 000 000. This in turn would cause inventory to increase by $150 000, accounts receivable to increase by $100 000, and accounts payable to increase by $75 000. What is the firm's expected change in net working capital?

A)$325 000
B)$175 000
C)$250 000
D)$1 175 000

Question 47

What are 'sunk costs'?

Question 48

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

A firm is considering investing in a new machine that will cost $600 000 and will be depreciated using the straight-line method over five years. If the firm's marginal tax rate is 30%, what is the annual depreciation tax shield of purchasing the machine?

A)$36 000
B)$120 000
C)$234 000
D)$107 692

Question 49

Use the information for the question(s)below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows (in millions)for the first two years.

The depreciation tax shield for the Shepard Industries project in year 1 is closest to:

A)$96
B)$84
C)$60
D)$72

Question 50

Use the information for the question(s)below.
Temporary Housing Services (THS)is considering a project that involves setting up a temporary housing facility in an area recently damaged by a cyclone. THS will lease space in this facility to various agencies and groups providing relief services to the area. THS estimates that this project will initially cost $6 million to set up and will generate $22 million in revenues during its first and only year of operation (paid in one year). Operating expenses are expected to total $13 million during this year and depreciation expense will be another $4 million. THS will require no working capital for this investment. THS's marginal tax rate is 30%.
Ignoring the original investment of $6 million, what is THS's free cash flow for the first and only year of operation?

A)$6.0 million
B)$6.75 million
C)$7.5 million
D)$8.0 million

Question 51

Use the table for the question(s)below.
You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an investment of $40 000 in new equipment. This equipment will be depreciated using the straight-line method over five years. If your firm's marginal corporate tax rate is 30%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation?

A)$26 000
B)$2 400
C)$14 000
D)$5 200

Question 52

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated using the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
The required net working capital in the second year for the Sisyphean Corporation's project is closest to:

A)$4 880
B)$3 190
C)$4 400
D)$3 960

Question 53

Use the information for the question(s)below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows (in millions)for the first two years.

The depreciation tax shield for the Shepard Industries project in year 2 is closest to:

A)$60
B)$96
C)$72
D)$84

Question 54

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

The free cash flow for the first year of Epiphany's project is closest to:

A)$47 750
B)$47 000
C)$39 000
D)$45 000

Question 55

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

A firm is considering a new project that will generate cash revenue of $1 000 000 and cash expenses of $700 000 per year for five years. The equipment necessary for the project will cost $200 000 and will be depreciated using the straight-line method over four years. What is the expected free cash flow in the second year of the project if the firm's marginal tax rate is 30%?

A)$225 000
B)$245 000
C)$195 000
D)$162 500

Question 56

What are 'project externalities'?

Question 57

Use the information for the question(s)below.
Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects:

Luther Industries has outstanding tax loss carryforwards of $70 million from losses over the past four years. If Luther earns $15 million per year in pre-tax income from now on, in how many years will Luther first pay taxes?

A)4 years
B)7 years
C)5 years
D)2 years

Question 58

Use the information for the question(s)below.
Temporary Housing Services (THS)is considering a project that involves setting up a temporary housing facility in an area recently damaged by a cyclone. THS will lease space in this facility to various agencies and groups providing relief services to the area. THS estimates that this project will initially cost $6 million to set up and will generate $22 million in revenues during its first and only year of operation (paid in one year). Operating expenses are expected to total $13 million during this year and depreciation expense will be another $4 million. THS will require no working capital for this investment. THS's marginal tax rate is 30%.
Assume that THS's cost of capital for this project is 15%. The net present value (NPV)of this temporary housing project is closest to:

A)-$435 000
B)$520 000
C)$1 960 000
D)-$650 000

Question 59

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated using the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
The change in net working capital from year 1 to year 2 is closest to:

A)an increase of $396
B)a decrease of $360
C)a decrease of $396
D)an increase of $360

Question 60

Use the information for the question(s)below.
The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30 000 and the machine will be depreciated using the straight-line method over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2 000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%.
The required net working capital in the third year for the Sisyphean Corporation's project is closest to:

A)$4 356
B)$5 940
C)$3 960
D)$4 360

Question 61

What is the most important function of 'sensitivity analysis'?

Question 62

An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of the diminishing value method of depreciation.

Question 63

Use the figure for the question(s)below.
The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the cost of manufacturing the knives, the selling price of the knives, the number of knives that will then be sold, and the project's net present value (NPV). Which of the following best describes what type of analysis the manager is performing?

A)break-even analysis
B)EBIT break-even analysis
C)sensitivity analysis
D)scenario analysis

Question 64

A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. Which parameter should be scrutinised most carefully in the estimation process?

A)cost of goods
B)sales price
C)units sold
D)cost of capital

Question 65

A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. If the best-case assumptions for Net Working Capital are met, what will the net present value (NPV)of this project be?

A)$1.7 million
B)$3 million
C)$2 million
D)$0.65 million

Question 66

What are the most difficult parts of 'capital budgeting'?

Question 67

Firms should use the most accelerated depreciation scheme allowable.

Question 68

Use the figure for the question(s)below.
A maker of computer games expects to sell 500 000 games at a price of $49 per game. These units cost $12 to produce. Selling, general, and administrative expenses are $1.2 million and depreciation is $280 000. What is the EBIT break-even point for the number of games sold in this case?

A)$40 000
B)$24 865
C)$30 192
D)$30 204

Question 69

Use the figure for the question(s)below.
The graph above shows the break-even analysis for the cost of making a certain good. Based on this chart, which of the following is true?

A)The project should not be undertaken if the predicted cost of goods sold is less than $110.
B)The net present value (NPV)of the project increases with increased cost of goods sold.
C)If the good costs $110 to make, the net present value (NPV)of the project will be zero.
D)The net present value (NPV)of the project will be positive if the cost of goods sold is greater than $110.

Question 70

A company planning to market a new model of motor scooter analyses the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2 480. What does this mean?

A)The predicted selling price of the motor scooter is $2 480.
B)If the motor scooter is sold for $2 480, then the net present value (NPV)for the product will be zero.
C)The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV)is $2 480.
D)If the motor scooter is sold for $2 480, then the project will make a profit.

Question 71

A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. How should the $20 million best be considered?

A)as an opportunity cost
B)as a capital cost
C)as a sunk cost
D)as a fixed overhead expense

Question 72

An insurance office owns a large building. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?

A)the cost of the research into the feasibility of renting the sixth floor
B)the cost of refurbishing the new space to be occupied by the Human Resources Department
C)the amount obtained by renting the sixth floor
D)cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spaces

Question 73

What is 'break-even analysis'?

Question 74

Use the figure for the question(s)below.
A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80 each to produce. Selling, general, and administrative (SG&A)expenses are $500 000. The machinery required to produce the knives cost $1.4 million, depreciated by straight-line depreciation over five years. The maker determines that the EBIT break-even point for units sold and sale price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A, and depreciation are greater than these estimates, so decides to go ahead with manufacturing the knife. Was this the correct decision?

A)Yes, since a positive EBIT ensures that the project will have a positive net present value (NPV).
B)No, since the cost per unit should be greater than the EBIT break-even point for cost of goods if the project is to have a positive EBIT.
C)Yes, since if the estimates for each parameter are correct, the EBIT will be positive.
D)It cannot be determined whether the decision was correct, since other factors contributing to the project's net present value (NPV), such as the upfront investment, have not been included in the analysis.

Question 75

The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital.

Question 76

Which of the following best explains why it is sensible for a firm to use an accelerated depreciation schedule rather than straight-line depreciation?

A)The firm will have substantially fewer depreciation expenses later in the depreciation timeline.
B)The firm can decide over how many years an item may be depreciated, thus allowing it full control of its depreciation expenses.
C)The firm will substantially decrease its depreciation tax shield across all of the depreciation timeline.
D)The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV).

Question 77

Use the table for the question(s)below.
Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision (all quantities in millions of dollars). It is thought that if marketing expenses are increased by 40%, then revenues will rise. By how much will revenues have to rise for the net present value (NPV)of the project to increase?

A)at least 2.9%
B)at least 3.8%
C)at least 2.0%
D)at least 3.2%

Question 78

Use the table for the question(s)below.
Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision. There are concerns of the sensitivity of this project to changes in the cost of capital. For what cost of capital does this project break even?

A)12%
B)14%
C)18%
D)16%

Question 79

Use the figure for the question(s)below.
The EBIT break-even point can be calculated using which of the following formulas?

A)(Units Sold × Sale Price)+ (Units Sold × Cost per unit)- SG&A - Depreciation = 0
B)(Units Sold × Sale Price)- (Units Sold × Cost per unit)+ SG&A + Depreciation = 0
C)(Units Sold × Sale Price)+ (Units Sold × Cost per unit)+ SG&A - Depreciation = 0
D)(Units Sold × Sale Price)- (Units Sold × Cost per unit)- SG&A - Depreciation = 0

Question 80

Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realise that he will not enjoy it. He goes to see it anyway, rationalising that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy?

A)No, because going to see the movie means that the product of his initial investment was realised as originally planned.
B)Yes, since he invested a valuable asset, his time, in a project based on its previous costs.
C)No, because the cost of the movie was not recoverable and would have been lost whatever action he took.
D)No, because he incurred no further costs by going to see the movie.