Deck 9: Fundamentals of Capital Budgeting

Question 1

Which of the following best defines incremental earnings?

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

Answer 1

the amount by which a firm's earnings are expected to change as a result of an investment decision

Question 2

The capital budgeting process begins by ________.

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

Answer 2

compiling a list of potential projects

Question 3

A capital budget lists the potential projects a company may undertake in future years.

Answer 3

False

Question 4

CathFoods will release a new range of candies which contain anti-oxidants. New equipment to manufacture the candy will cost which will be depreciated by straight-line depreciation over six years. In addition, there will be spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of per year for five years with production and support costs of $1.5 million per year. If CathFoods' marginal tax rate is 35%, what are the incremental earnings in the second year of this project?

A) $2.492 million
B) $2.100 million
C) $3.833 million
D) $1.342 million

Question 5

An oil company is buying a semi-submersible oil rig for $15 million. Additionally, it will cost 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 yearly depreciation expenses in this case?

A) $2.7 million
B) $3.0 million
C) $3.3 million
D) $3.8 million

Question 6

Cameron Industries is purchasing a new chemical vapor 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 delivery and install cost only
B) the cost of the depositor only
C) the delivery and install cost and the cost of the depositor
D) None of these costs should be reported an an operating expense.

Question 7

A stationery company plans to launch a new type of indelible ink pen. Advertising for the new product will be heavy and will cost the company $8 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 35% on its pretax income, what effect will the advertising for the new pen have on its taxes?

A) It will increase taxes by $8 million.
B) It will increase taxes by $2.8 million.
C) It will have no effect on taxes.
D) It will reduce taxes by $2.8 million.

Question 8

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

Question 9

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost to buy the machine and $12,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case?

A) $666,667
B) $668,667
C) $1,166,667
D) $1,168,667

Question 10

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

Question 11

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

Question 12

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

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 and there will be an additional cost to reconfigure existing plant. The equipment is expected to have a lifetime of nine 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 gallons per year at a price of $53 per gallon. It will take $36 per gallon to manufacture and support the product. If Vernon-Nelson's marginal tax rate is 40%, what are the incremental earnings after tax in year 3 of this project?

A) $25.5 million
B) $14.3 million
C) $23.8 million
D) $9.5 million

Question 14

Which of the following is NOT a factor that a manager should bear in mind when estimating a project's revenues and costs?

A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated or faces increased competition.
B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product.
C) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline.
D) Prices and costs tend to rise with the general level of inflation in the economy.

Question 15

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

Question 16

The ultimate goal of the capital budgeting process is to ________.

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

Question 17

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

Question 18

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

Question 19

A brewer is launching a new product: brewed ginger ale with a low alcohol content. The brewer plans to spend promoting this product this year, which is expected to expand the sales of this product to this year and next year. They do expect there will be loss of sales of this year and next year in their other products as customers switch to drinking the new ginger ale. The gross profit margin for the new ginger ale 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 35%. What are incremental earnings arising from the promotional campaign this year?

A) $1.625 million
B) $1.26 million
C) $2.11 million
D) $4.40 million

Question 20

A small manufacturer that makes clothespins and other household products buys new injection molding equipment for a cost of $500,000. This will allow the manufacturer to make more clothespins in the same amount of time with an estimated increase in sales of 25%. If the manufacturer currently makes 75 tons of clothespins per year, which sell at $18,000 per ton, what will be the increase in revenue next year from the new equipment?

A) $125,000
B) $303,750
C) $337,500
D) $837,500

Question 21

CathFoods will release a new range of candies which contain antioxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over four years. In addition, there will be $5 million spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of $4 million per year for four years with production and support costs of $1.5 million per year. If CathFoods' marginal tax rate is 35%, what are the incremental free cash flows in the second year of this project?

A) $1.800 million
B) $1.400 million
C) $2.000 million
D) $0.700 million

Question 22

Food For Less (FFL), a grocery store, is considering offering one-hour photo developing in their store. The firm expects that sales from the new one-hour machine will be $175,000 per year. FFL currently offers overnight film processing with annual sales of $90,000. While many of the one-hour photo sales will be to new customers, FFL estimates that 40% of their current overnight photo customers will switch and use the one-hour service. The level of incremental sales associated with introducing the new one hour photo service is closest to ________.

A) $139,000
B) $175,000
C) $36,000
D) $70,000

Question 23

Which of the following would you NOT consider when making a capital budgeting decision?

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

Question 24

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 25

Balance Sheet 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) $126 thousand
B) $7 thousand
C) $46 thousand
D) $86 thousand

Question 26

Which of the following statements is FALSE?

A) Many projects use a resource that the company already owns.
B) When evaluating a capital budgeting decision, we generally include interest expense.
C) 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.
D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.

Question 27

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

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

Question 28

How are the taxes paid under MACRS different from that paid under straight-line depreciation?

Question 29

Which of the following is an example of cannibalization?

A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.
B) A grocery store begins selling T-shirts featuring the local university's mascot.
C) A basketball manufacturer adds basketball hoops to its product line.
D) A convenience store begins selling pre-paid cell phones.

Question 30

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $5,000,000 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 $4,500,000 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 40%. What are the incremental free cash flows associated with the new machine in year 2?

A) $835,000
B) $2,665,000
C) $2,434,000
D) $831,667

Question 31

Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $7,000,000 to buy the machine and $20,000 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 $4,500,000 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 seven years and will be depreciated over those seven years. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 0?

A) -$10,020,000
B) -$7,000,000
C) -$9,018,000
D) $1,002,857

Question 32

Ford Motor Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $30 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 30% tax rate on its pre-tax income. The amount that Ford Motor Company owes in taxes next year with the launch of the new SUV is closest to ________.

A) $15.0 million
B) $9.0 million
C) $33.0 million
D) $24.0 million

Question 33

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

Question 34

Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?

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

Question 35

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.

Question 36

Ford Motor Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 35% tax rate on its pre-tax income. The amount that Ford Motor Company owes in taxes next year without the launch of the new SUV is closest to ________.

A) $28.0 million
B) 12.3 million
C) $40.3 million
D) $15.8 million

Question 37

Which of the following statements is FALSE?

A) We begin the capital budgeting process by determining the incremental earnings of a project.
B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre-tax income.
C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings.
D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.

Question 38

A company buys tracking software for its warehouse which, along with the computer system and ancillaries to run it, will cost $1.6 million. This purchase will be deducted over five years. It is expected that the software will reduce inventory by $10.7 million at the end of the first year after it is installed, though there will be an annual cost of $120,000 per year to run the system. If the company's marginal tax rate is 40%, how will the purchase of this item change the company's free cash flows in the first year?

A) $10.756 million
B) $10.380 million
C) $9.680 million
D) $11.832 million

Question 39

A firm reports that in a certain year it had a net income of $5.0 million, depreciation expenses of $3.0 million, capital expenditures of $2.0 million, and Net Working Capital decreased by $1.1 million. What is the firm's free cash flow for that year?

A) $11.1 million
B) $7.1 million
C) $5.1 million
D) $4.9 million

Question 40

If available, should MACRS be preferred to straight-line depreciation?

Question 41

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) $45,600
B) $28,500
C) $38,000
D) $53,200

Question 42

Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows for the first two years (in millions). The depreciation tax shield for Shepard Industries project in year 1 is closest to ________.

A) $84 million
B) $104 million
C) $83 million
D) $69 million

Question 43

A garage is installing a new "bubble-wash" car wash. It will promote the car wash as a fun activity for the family, and it is expected that the novelty of this approach will boost sales in the medium term. If the cost of capital is 10%, what is the net present value (NPV) of this project?

A) -$135,493
B) -$143,021
C) $165,603
D) $150,548

Question 44

Bubba Ho-Tep Company reported net income of $290 million for the most recent fiscal year. The firm had depreciation expenses of $100 million and capital expenditures of $150 million. Although it had no interest expense, the firm did have an increase in net working capital of $30 million. What is Bubba Ho-Tep's free cash flow?

A) $10 million
B) $210 million
C) $270 million
D) $570 million

Question 45

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 $130,000; however, a commercial real estate agent has informed you that an outside buyer is interested in purchasing this land would be willing to pay $700,000 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) $700,000
B) $0
C) $130,000
D) $830,000

Question 46

You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an investment of $47,000 in new equipment. This equipment will be depreciated straight-line over five years. If your firm's marginal corporate tax rate is 35%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation?

A) $3290
B) $16,450
C) $6110
D) $30,550

Question 47

Cromwell Industries is considering a new project which will have costs, revenues, etc. as shown by the data above. If the cost of capital is 8.0%, what is the net present value (NPV) of this project?

A) -$56,662
B) -$59,810
C) $62,958
D) $69,254

Question 48

A firm is considering changing their credit terms. It is estimated that this change would result in sales increasing by $1,600,000. This in turn would cause inventory to increase by $125,000, accounts receivable to increase by $100,000, and accounts payable to increase by $90,000. What is the firm's expected change in net working capital?

A) $1,735,000
B) $315,000
C) $225,000
D) $135,000

Question 49

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) $23,387
B) $140,319
C) $46,773
D) $93,546

Question 50

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 straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2400 canes in year 1. Sales are estimated to grow by 9% each year through year 3. The price per cane that Sisyphean will charge its customers is $15 each and is to remain constant. The canes have a cost per unit to manufacture of $8 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 3% of its annual sales in cash, 5% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 8%.
The change in net working capital from year 1 to year 2 is closest to ________.

A) a decrease of $356
B) an increase of $356
C) an increase of $389
D) a decrease of $389

Question 51

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) $65,750
B) $59,175
C) $49,313
D) $52,600

Question 52

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If Sisyphean's marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the company's new project?

A) $1,080,000
B) $1,260,000
C) $1,890,000
D) $1,134,000

Question 53

You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an increase in inventory of $8700, an increase in accounts payables of $2300, and an increase in property, plant, and equipment of $48,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is ________.

A) $54,400
B) $11,000
C) $7680
D) $6400

Question 54

Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI 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 in operation (paid in one year). Operating expenses are expected to total $11 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35%. Ignoring the original investment of $5 million, what is THSI's free cash flow for the first and only year of operation?

A) $6.00 million
B) $3.85 million
C) $9.81 million
D) $7.85 million

Question 55

Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $21 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $8 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35% Assume that THSI's cost of capital for this project is 15%. The net present value (NPV) of this temporary housing project is closest to ________.

A) $2,956,522
B) -$9.15
C) $5,913,044
D) -$2,956,522

Question 56

A firm is considering investing in a new machine that will cost $400,000 and will be depreciated straight-line over five years. If the firm's marginal tax rate is 39%, what is the annual depreciation tax shield of purchasing the machine?

A) $80,000
B) $31,200
C) $28,080
D) $156,000

Question 57

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 straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2500 canes in year 1. Sales are estimated to grow by 9% each year through year 3. The price per cane that Sisyphean will charge its customers is $16 each and is to remain constant. The canes have a cost per unit to manufacture of $10 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 3% of its annual sales in cash, 5% of its annual sales in accounts receivable, 10% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 9%.
The required net working capital in the first year for the Sisyphean Corporation's project is closest to ________.

A) $5200
B) $5668
C) -$2800
D) $9200

Question 58

Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected that the project will produce the following cash flows for the first two years (in millions of dollars). The depreciation tax shield for Shepard Industries project in year 2 is closest to ________.

A) $90 million
B) $69 million
C) $135 million
D) $108 million

Question 59

Luther Industries has outstanding tax loss carryforwards of $72 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) 7 years
B) 2 years
C) 4 years
D) 5 years

Question 60

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 straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% each year through year 3. The price per cane that Sisyphean will charge its customers is $17 each and is to remain constant. The canes have a cost per unit to manufacture of $8 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, 5% of its annual sales in accounts receivable, 10% of its annual sales in inventory, and 6% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 9%.
The required net working capital in the second year for the Sisyphean Corporation's project is closest to ________.

A) $4114
B) $3740
C) -$3366
D) $8602

Question 61

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

Question 62

A textile company invests $10 million in an open-end spinning machine. This was depreciated using the seven-year MACRS schedule shown above. If the company sold it immediately after the end of year 3 for $7 million, what would be the after-tax cash flow from the sale of this asset, given a tax rate of 40%?

A) $1,550,400
B) $3,124,000
C) $3,876,000
D) $5,449,600

Question 63

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

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

Question 64

A fast-food company invests $2.2 million to buy machines for making slurpees. These can be depreciated using the MACRS schedule shown above. If the cost of capital is 10%, what is the increase in the net present value (NPV) of the product gained by using MACRS depreciation over straight-line depreciation for three years?

A) $28,559
B) $47,599
C) $76,158
D) $190,321

Question 65

Firms should use the most accelerated depreciation scheme allowable.

Question 66

Visby Rides, a livery car company, is considering buying some new luxury cars. After extensive research, they come up with the above estimates of free cash flow from this project. The depreciation schedule shown is for three-year, straight-line depreciation. By how much would the net present value (NPV) of this project be increased, if the cars were depreciated by the MACRS schedule shown below given that the cost of capital is 10%?

A) $7266
B) $9082
C) $10,898
D) $22,705

Question 67

Which of the following is an example of cannibalization?

A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.
B) A grocery store begins selling T-shirts featuring the local university's mascot.
C) A basketball manufacturer adds basketball hoops to its product line.
D) A convenience store begins selling pre-paid cell phones.

Question 68

What are the most difficult parts of capital budgeting?

Question 69

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

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

Question 70

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 71

What is the most important function of sensitivity analysis?

Question 72

A bakery invests $40,000 in a light delivery truck. This was depreciated using the five-year MACRS schedule shown above. If the company sold it immediately after the end of year 2 for $21,000, what would be the after-tax cash flow from the sale of this asset, given a tax rate of 40%?

A) $11,520
B) $9480
C) $3792
D) $17,208

Question 73

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

Question 74

A firm is considering a new project that will generate cash revenue of $1,300,000 and cash expenses of $700,000 per year for five years. The equipment necessary for the project will cost $300,000 and will be depreciated straight line 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 35%?

A) $374,625
B) $341,250
C) $416,250
D) $499,500

Question 75

MACRS
A machine is purchased for $575,000 and is used through the end of Year 2. The machine will be depreciated using the 3-Year MACRS schedule. At the end of Year 2, the machine is sold for $75,000. What is the after-tax cash flow from the sale of the machine at the end of Year 2 if the firm's marginal tax rate is 35%?

A) $42,608
B) $15,916
C) $32,392
D) $63,663

Question 76

MACRS
A firm is considering the purchase of a new machine for $325,000. The firm is unsure if it should use the 3-Year MACRS schedule or straight-line depreciation over three years. What is the difference in the book value after three years if the firm uses MACRS instead of straight-line depreciation?

A) $0
B) $24,083
C) $48,166
D) $300,918

Question 77

The term "cannibalization" refers to ________.

A) decrease in the sales of current project caused by the launching of new project
B) decrease in the sunk cost caused by launching of new project
C) decrease in overhead expenses incurred due to launch of new project
D) cost of using a resource for the best value it could provide in its best alternative

Question 78

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 straight line over its three-year life to a residual value of The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year 3. The price per cane that Sisyphean will charge its customers is each and is to remain constant. The canes have a cost per unit to manufacture of 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 35% 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) $10,500
B) $3500
C) $3150
D) $2800

Question 79

Massive Amusements, an owner of theme parks, invests $65 million to build a roller coaster. This can be depreciated using the MACRS schedule shown above. How much less is the depreciation tax shield for year 4 under MACRS depreciation than under 7-year, straight-line depreciation, if the tax rate is 35%?

A) $974,680
B) $1,218,350
C) $2,193,030
D) $6,091,750

Question 80

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

A) The firm will substantially decrease its depreciation tax shield across all of 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 have substantially fewer depreciation expenses later in 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).