Deck 12: Analyzing Project Cash Flows

Question 1

Incremental cash flows from a project =

A) Firm cash flows without the project plus or minus changes in net income.
B) Firm cash flows with the project plus firm cash flows without the project.
C) Firm cash flows with the project minus firm cash flows without the project.
D) Firm cash flows without the project plus or minus changes in revenue with the project.

Answer 1

C

Question 2

Which of the following is NOT considered in the calculation of incremental cash flows?

A) Depreciation tax shield
B) Sunk costs
C) Opportunity costs
D) Both A and B

Answer 2

B

Question 3

Stoneberg Printers purchased a press 4 years ago at a cost of $500,000. They are evaluating a more efficient replacement press which will cost $750,000. Both the old press and the replacement would be depreciated using 5 year MACRS. What would be the change in depreciation expense in the first year if the new press is purchased?

A) $42,500 increase
B) $92,500 increase
C) $57,500 decrease
D) $150,000 increase

Answer 3

A

Question 4

How is interest expense that is associated with a project treated in the capital budgeting process?

A) It is treated as a cash outflow when estimating the incremental cash flows associated with a project.
B) It is built into the discount rate.
C) It is considered a synergistic incremental cash flow.
D) Interest expense is not relevant to any capital budgeting decisions.

Question 5

Which of the following is NOT one of the categories for a project's relevant after-tax cash flows?

A) Financing flows
B) Initial cash outflow
C) Differential flows over the project's life
D) Terminal cash flow

Question 6

Which of the following cash flows should not be included as incremental costs or revenues when evaluating capital projects?

A) A new security system will reduce shoplifting losses by $50,000 per year.
B) Thirty percent of the sales of a new product will result from customers switching from the previous version of the product.
C) Interest on construction loans will increase interest expense by $225,000 per year.
D) The project will occupy space which is currently being rented to another business for $3,000 per month.

Question 7

Which of the following expenses should be included when estimating cash flows for investment projects?

A) Interest expense related to financing a project
B) Sunk costs
C) Required principal payments related to financing a project
D) Opportunity costs

Question 8

Which of the following cash flows should be included as incremental costs when evaluating capital projects?

A) Investment in working capital that is directly related to a project
B) Expenses that are incurred in order to modify a firm's production facility in order to invest in a project
C) Opportunity costs that are directly related to a project
D) All of the above

Question 9

Holding all other variables constant, which of the following would INCREASE net working capital for given year on a project?

A) Allowing customers less time to pay for purchases
B) Taking longer to pay suppliers
C) Increasing inventory levels
D) Both A and C

Question 10

Relevant incremental cash flows include

A) sales captured from the firm's competitors.
B) retained sales that would have been lost to new competing products.
C) incremental sales brought to the firm as a whole.
D) all of the above.

Question 11

Which of the following is an example of a sunk cost?

A) Overhead costs that are associated with a project
B) Interest expense associated with a project
C) Market study expenses incurred in order to decide if a firm should accept a project
D) Depreciation expenses associated with a project

Question 12

Which of the following overhead expenses is a relevant, incremental cash flow?

A) The project will represent 10% of the firm's revenues, so 10% of the CEO's compensation is allocated to the project.
B) The project will occupy 10% of the firm's available space, so 10% of the firm's property insurance is allocated to the project.
C) The project will increase the number of employees by 10%, so an additional human resources assistant must be hired to handle personnel issues directly related to the project.
D) None of the expenses above should be allocated to the project.

Question 13

Which of the following would be considered a terminal cash flow?

A) The expected salvage value of the asset
B) Any tax payments or refunds associated with the salvage value of the asset
C) Recapture of any investment in working capital that was included as an incremental cash outlay
D) All of the above

Question 14

J&P Accounting purchased new tax software two years ago. The software is still useable, but faster, more comprehensive software is available. If J&P purchases the new software, the cost of the old software is

A) a sunk cost.
B) an opportunity cost.
C) a terminal expense.
D) an overhead expense.

Question 15

The calculation of differential cash flows over a project's life should include which of the following?

A) Labor and material savings
B) Additional revenues attributable to the project
C) Investment in net working capital
D) All of the above

Question 16

When evaluating Capital Budgeting decisions, which of the following items should NOT be included in the construction of cash flow projections for purposes of analysis?

A) Net salvage value
B) Changes in net working capital requirements
C) Shipping and installation costs
D) All of the above should be included.

Question 17

Which of the following is the best example of an incremental cash inflow/outflow?

A) Cash flows that are achieved by diverting sales from other projects of the firm
B) Cash flows that are associated with the financing of a project
C) Cash flows that occur a little at a time
D) What the total cash flows will be to the company if the project is undertaken as opposed to what they would have been if the project had not been undertaken

Question 18

Depreciation expenses affect tax-related cash flows by

A) increasing taxable income, thus increasing taxes.
B) decreasing taxable income, thus reducing taxes.
C) decreasing taxable income, but not altering cash flows since depreciation is not a cash expense.
D) all of the above.

Question 19

Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal?

A) Increase in accounts receivable
B) The cost of shipping new equipment
C) The cost of issuing new bonds if the project is financed by a new bond issue
D) The cost of installing new equipment

Question 20

Which of the following is NOT part of a project's initial cash outflow?

A) The asset's purchase price
B) Funds committed to support increased inventory levels due to expected increased sales if the firm adopts the project
C) A marketing survey completed last year to determine the project's feasibility
D) Expenses incurred to install the asset

Question 21

Anderson-EOG Inc. is evaluating the the construction of a gas pipeline to bring natural gas from Western New York state to New York City. The controller argues that every project of the company has to absorb a portion of administrative overhead including corporate headquarters and executive salaries. The Treasurer argues that these costs are irrelevant because they are merely being shifted from part of the company to another. Who is correct?

Question 22

Cape Cod Cranberries will finance a new organic juice production facility with a $10,000,000 bond issue. Interest on the bonds will be $637,500 per year for the life of the project. Should the interest payments be subtracted from the project's incremental cash flows?

Question 23

Anderson-EOG Inc. is evaluating the the construction of a gas pipeline to bring natural gas from Western New York state to New York City. The controller argues that depreciation has to be included among the expenses. The Treasurer argues that depreciation is irrelevant because it does not affect cash flow. Who is correct?

Question 24

Incremental cash flows include all of the following EXCEPT:

A) research and development costs.
B) increased labor costs from the project.
C) advertising costs .
D) both B and C.

Question 25

In measuring cash flows we are interested only in the incremental or differential after-tax cash flows that are attributed to the investment proposal being evaluated.

Question 26

Sunk costs are a type of incremental cash flow that should be included in all capital-budgeting decisions.

Question 27

Terminal cash flows can include expenses as well as revenues.

Question 28

Thaler & Co. anticipates an increase of $1,000,000 in Net Operating Income from first year sales of a new product. Taxes will be $350,000 and the company took $150,000 in depreciation expense. Operating cash flow equals

A) $1,000,000.
B) $500,000.
C) $800,000.
D) $650,000.

Question 29

Cape Cod Cranberries is evaluating the introduction of a new line of organic cranberry products. Market research suggests that approximates 1/3 of sales of the new products will come at the expense of existing product lines. How should this "cannibalization effect" be incorporated into the analysis.

Question 30

A company converts space to use as a manufacturing facility. Previously it was rented to another company as a warehouse. This is an example of a sunk cost.

Question 31

Briefly explain why each of the following should or should not be considered in forecasting incremental cash flows from a project:
a. the cost of building a prototype of a new product to see if it was feasible.
b. market research suggests that after buying a company's "smart phone" customers will begin to buy more of the same company's notebook computers.
c. a company decides to use existing space for storage. The company could have rented the space to another business for $2,500 a month.

Question 32

The owner of a convenience store is considering adding a take-out sandwich section to her offerings. The new activity will occupy 25% of the space and account for 30% of total revenues. Property insurance on the building is $9,000 per year and will not change because of the new activity. How much of the insurance premium should be allocated to the new product line?

A) $2,700
B) $2,475
C) $2,250
D) $0.00

Question 33

The pertinent issue for determining whether overhead costs should be part of a project's relevant after-tax cash flow is whether the project benefits from the overhead items.

Question 34

The initial outlay involves the immediate cash outflow necessary to purchase the asset and put it in operating order.

Question 35

To be conservative, capital budgeting analysis assumes that projects cannot add sales to existing lines of business.

Question 36

Schiller Construction Inc. has estimated the following revenues and expenses related to phase I of a proposed new housing development. Incremental sales= $5,000,000, total cash operating expenses $3,500,000, depreciation $500,000, taxes 35%, interest expense, $200,000. Operating cash flow equals

A) $650,000.
B) $1,000,000.
C) $1,150,000.
D) $975,000.

Question 37

When determining how much overhead cost to include in incremental cash flows for a capital budgeting decision, the allocation of overhead by the accounting department based on percentage of space used by a project should always be used.

Question 38

The initial outlay of an asset does not include installation costs.

Question 39

When replacing an existing asset, the cash inflow associated with the sale of the old asset and any related tax effects must be considered and accounted for in the analysis.

Question 40

Mr. Smith included the cost of test marketing before production in the calculation of the initial outlay. Apparently, Mr. Smith does not understand the concept of

A) side-effect costs.
B) opportunity costs.
C) sunk costs.
D) variable costs.

Question 41

ABC already spent $85,000 on a feasibility study for a machine that will produce a new product. The machine will cost $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after which it will be sold for $600,000. What is the depreciable cost basis of the machine?

A) $3,025,000
B) $2,950,000
C) $2,575,000
D) $2,350,000

Question 42

ABC will purchase a machine that will cost $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. ABC plans to depreciate the machine by using the straight-line method. The machine is expected to increase ABC's sales revenues by $1,890,000 per year; operating costs excluding depreciation are estimated at $454,600 per year. Assume that the firm's tax rate is 40%. What is the annual operating cash flow?

A) $922,464
B) $1,126,287
C) $813,563
D) $1,029,811

Question 43

Which of the following is included in the calculation of the initial outlay for a capital investment?

A) Investment in working capital
B) A feasibility study conducted the previous year.
C) Installation
D) A and C but not B

Question 44

The machine's after-tax incremental cash flow in year five is

A) $6,980.
B) $5,980.
C) $7,120.
D) $8,620.

Question 45

Which of the following would increase the net working capital for a project? An increase in

A) accounts receivable.
B) fixed assets.
C) accounts payable.
D) common stock.

Question 46

ABC already spent $85,000 on a feasibility study for a machine that will produce a new product. The machine will cost $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after which it will be sold for $600,000. What is the total investment amount required for the project?

A) $3,025,000
B) $2,950,000
C) $2,575,000
D) $2,350,000

Question 47

XYZ, Inc. is considering adding a product line that would utilize floor space in their manufacturing plant which is currently used for storage. XYZ will need to rent new storage space elsewhere. The floor space would be considered a(n)

A) variable cost.
B) opportunity cost.
C) sunk cost.
D) irrelevant cash flow.

Question 48

If the federal income tax rate were increased, the impact of the tax increase on acceptable investment proposals would be to (ignore the impact of the tax change on the cost of capital)

A) decrease the tax shelter from depreciation.
B) decrease net present value but the internal rate of return would stay the same.
C) increase net present value because the tax shelter from interest and depreciation becomes more valuable.
D) decrease both net present value. and internal rate of return.

Question 49

The machine's IRR is

A) less than 0.
B) greater than 12 percent.
C) less than 12 percent.
D) equal to 12 percent.

Question 50

Diamond Inc. has estimated that a new building will cost $2,500,000 to construct. Land was purchased a year ago for $500,000 and could be sold today for $550,000. An environmental impact study required by the state was performed at a cost of $48,000. For capital budgeting purposes, what is the relevant cost of the new building?

A) $2,500,000
B) $3,048,000
C) $3,050,000
D) $3,098,000

Question 51

Which of the following should be included in the initial outlay?

A) Shipping and installation costs
B) Increased working capital requirements
C) Cost of employee training associated specifically with the asset being evaluated
D) All of the above

Question 52

The machine's NPV is

A) $1,556.56.
B) $2,556.56.
C) $1,123.99.
D) $2,123.99.

Question 53

The machine's incremental after-tax cash inflow for year 1 is

A) $6,420.
B) $7,980.
C) $8,620.
D) $5,980.

Question 54

If depreciation expense is taken over 5 years rather than 3 years, all things equal,

A) net present value will go down.
B) depreciation has no effect on net present value.
C) net present value will go up.
D) the answer depends on the company's marginal tax rate.

Question 55

If SuperMart decides to offer a line of groceries at its discount retail outlet, inventories are expected to increase by $1,200,000, accounts receivable by $300,000 and accounts payable by $500,000. What is the cash outflow for working capital requirements?

A) $2,000,000
B) $1,700,000
C) $1,500,000
D) $1,000,000

Question 56

The initial investment for this decision is

A) $20,000.
B) $21,000.
C) $27,000.
D) $23,000.

Question 57

Depreciation expenses affect capital budgeting analysis by increasing

A) taxes paid.
B) incremental cash flows.
C) the initial outlay.
D) working capital.

Question 58

Which of the following is included in the terminal cash flow?

A) The expected salvage value of the asset
B) Tax impacts from selling assets
C) Recapture of any working capital
D) All of the above

Question 59

Which of the following may affect initial investment, interim operating cash flows and terminal cash flows?

A) changes in sales revenue
B) depreciation
C) changes in working capital
D) changes in interest rates

Question 60

A firm purchased an asset with a 5-year life for $90,000, and it cost $10,000 for shipping and installation. According to the current tax laws the cost basis of the asset at time of purchase is

A) $100,000.
B) $95,000.
C) $80,000.
D) $70,000.

Question 61

Jefferson Corporation is considering an expansion project. The necessary equipment could be purchased for $15 million and shipping and installation costs are another $500,000. The project will also require an initial $2 million investment in net working capital. The company's tax rate is 40%. What is the project's initial investment outlay (in millions)?

A) $15.0
B) $15.5
C) $17.0
D) $17.5

Question 62

Famous Danish Corp. is replacing an old cookie cutter with a new one. The cookie cutter is being sold for $25,000 and it has a net book value of $75,000. Assume that Famous Danish is in the 34% income tax bracket. How much will Famous Danish net from the sale?

A) $61,000
B) $55,000
C) $75,000
D) $42,000

Question 63

Which of the following would cause free cash flow to differ from operating cash flow when an investment project is terminated?

A) Sale of assets
B) Recovery of net working capital
C) Income taxes
D) All of the above

Question 64

The introduction of a new product at Elia Pharmaceuticals will require a $450,000 increase in inventory, a $730,000 increase in Accounts Receivable, and a $180,000 increase in Accounts Payable. Introduction of the product will also require a $700,000 expenditure for advertising. The increase in net working capital required for the introduction of this product is

A) $1,180,000.
B) $1,000,000.
C) $1,360,000.
D) $1,700,000.

Question 65

ABC purchased a machine for $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after-which it will be sold for $600,000. ABC plans to depreciate the machine by using the straight-line method. Assume that the firm's tax rate is 40%. What is the termination (non-operating) cash flow from the machine in year three?

A) $900,623
B) $1,109,286
C) $1,298,114
D) $879,247

Question 66

Because installation costs of a new asset are a current cash expense, they are excluded from the initial outlay.

Question 67

In the fourth and final year of a project, SVC expects operating cash flow of $440,000. The project required an $80,000 investment in working capital at the beginning. Of that amount, $60,000 will be recovered in year 4. Machinery associated with the project will be sold for exactly its undepreciated value of $15,000. Total free cash flow for the fourth year is

A) $75,000.
B) $1,500,000.
C) $515,000.
D) $535,000.

Question 68

Regal Enterprises is considering the purchase of a new embroidering machine. It is expected to generate additional sales of $400,000 per year. The machine will cost $295,000, plus $3,000 to install it. The embroiderer will save $12,000 in labor expense each year. Regal is in the 34% income tax bracket. The machine will be depreciated on a straight-line basis over five years (it has no salvage value). The embroiderer will require annual operating expenses of $136,000. What is the annual operating cash flow that the machine will generate?

A) $316,954
B) $124,000
C) $202,424
D) $165,816

Question 69

In year 3 of project Gamma. sales were $3,000,0000, cost of goods sold $1,500,000, other cash costs were $400,000, depreciation was $600,000 and interest expense was $250,000. The company's marginal tax rate is 35%. Compute operating cash flow for year 3 of project Gamma.

A) $925,000
B) $675,000
C) $500,000
D) $325,000

Question 70

Woodstock Inc. expects to own a building for five years, then sell it for $1,500,000 net of taxes, sales commissions and other selling costs. Woodstock's cost of capital is 11%. How much will the sale of the building contribute to the NPV of the project?

A) $890,177
B) $1,351,351
C) $1,500,000
D) $2,527,587

Question 71

Which of the following should be considered in the estimation of free cash flows?

A) Cash generated from the sale of a project
B) Recovery of net working capital
C) Operating cash flow
D) All of the above

Question 72

The method of depreciation generally used for tax reporting purposes is

A) straight line.
B) sum-of-the-year's digits.
C) ACRS.
D) MACRS.

Question 73

The Director of Capital Budgeting of Capital Assets Corp. is considering the acquisition of a new high speed photocopy machine. The photocopy machine is priced at $85,000 and would require $2,000 in transportation costs and $4,000 for installation. The equipment will have a useful life of 5 years. The proposal will require that Capital Assets Corp. send a technician for training at a cost of $5,000. The firm's marginal tax rate is 40 percent. How much is the initial cash outlay of the photocopy machine?

A) $64,000
B) $77,000
C) $81,000
D) $96,000

Question 74

When an old asset is sold for exactly its depreciated value, the only taxable income is the difference between the initial cost of the machine and the selling price.

Question 75

Tully's Tool and Die has the following projections for Year 1 of a capital budgeting project. Year 1 Incremental Projections:
Sales $400,000
Variable Costs $240,000
Fixed Costs $80,000
Depreciation Expense $40,000
Tax Rate 35%
Calculate the operating cash flow for Year 1.

A) $26,000
B) $66,000
C) $40,000
D) $38,200

Question 76

Jain's Pharmaceuticals is installing new lab equipment at a cost of $5 million with an economic life of 5 years. Jain's marginal tax rate is 35%. What is the difference in tax expense in the second year if depreciation is computed using MACRS rates rather than straight line?

A) $350,000 more
B) $210,000 more
C) $350,000 less
D) $210,000 less

Question 77

SpaceTech is considering a new project with the following projections for Year 2. Year 2 Projections
EBIT $400,000
Interest Expense $20,000
Depreciation Expense $40,000
Tax Rate 40%
Incremental Net Working
Capital Needs $200,000
Compute the operating cash flow for year 2.

A) $80,000
B) $180,000
C) $240,000
D) $280,000

Question 78

A project under consideration by Khalia Corporation will require the purchase of new equipment at a cost of $1,000,000 with a 3 year economic life. Kalia's marginal tax rate is 25%. What is the difference in tax expense in the second year if depreciation is computed using MACRS rates rather than straight line?

A) $445,000
B) $333,000
C) $112,000
D) $28,000

Question 79

The Board of Directors of Waste Free Chemicals is considering the acquisition of a new chemical processor. The processor is priced at $600,000 but would require $60,000 in transportation costs and $40,000 for installation. The processor will have a useful life of 10 years. The project will require Waste Free to increase its investment in accounts receivable by $80,000 and will also require an additional investment in inventory of $150,000. The firm's marginal tax rate is 40 percent. How much is the initial cash outlay of the processor?

A) $700,000
B) $850,000
C) $930,000
D) $1,040,000

Question 80

Jain's Pharmaceuticals is installing new lab equipment at a cost of $5 million with an economic life of 5 years. Jain's marginal tax rate is 35%. What is the difference in depreciation between straight line depreciation and MACRS depreciation in the second year.

A) $0.6 million
B) $1 million
C) $1.6 million
D) $1.75 million