Deck 12: Analyzing Project Cash Flows

Question 1

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

Answer 1

D

Question 2

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.

Answer 2

C

Question 3

Heating, lighting and rent are examples of:

A)depreciation tax shield
B)sunk costs
C)opportunity costs
D)overhead expenses

Answer 3

D

Question 4

What is the cash flow associated with the launching of the investment called?

A)Annual cash flow
B)Terminal cash flow
C)Initial cash outlay
D)Operating cash flow

Question 5

Which of the following is those costs that have already been incurred or are going to be incurred regardless of whether or not the investment is undertaken.

A)Depreciation tax shield
B)Sunk costs
C)Opportunity costs
D)Overhead expenses

Question 6

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 7

Archer Accounting purchased new tax software two years ago.The software is still useable, but faster, more comprehensive software is available.If Archer 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 8

Which of the following is not included in the Initial investment period?

A)Incremental revenue
B)Cost of equipment
C)Cost of installing equipment
D)Investment in working-capital requirements

Question 9

Incremental cash flows from a project =

A)Firm cash flows without the project plus or minus changes in net profit.
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.

Question 10

Incremental project cash flows=

A)Firm cash flows minus firm cash flows without the project
B)Firm cash flows plus firm cash flows without the project
C)Firm cash flows minus divided by cash flows without the project
D)Firm cash flows multiplied by firm cash flows without the project

Question 11

Which of the following is not included in the Interim operating period?

A)Costs of purchasing equipment
B)Incremental revenue
C)Increase in working-capital requirements
D)Incremental expenses

Question 12

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 $3000 per month.

Question 13

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 14

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 15

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 16

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 17

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 18

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 19

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 20

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 21

Kelvin Crackers is evaluating the introduction of a new line of organic cracker products.Market research suggests that approximately one-third 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 22

Anderson-EOG Inc.is evaluating the construction of a gas pipeline to bring natural gas from Western New York 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 23

Kelvin Crackers will finance a new organic cracker 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 24

Anderson-EOG Inc.is evaluating the construction of a gas pipeline to bring natural gas from Western New York 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 25

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 26

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

Question 27

Cash flows are the source of value.

Question 28

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

Question 29

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 $2500 a month.

Question 30

Enviro Co.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 31

Freedom Inc 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 [blank].

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

Question 32

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 33

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

Question 34

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

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

Question 35

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 36

Calculating project cash flows is a [blank] step procedure.

A)three
B)four
C)five
D)six

Question 37

Terminal cash flows can include expenses as well as revenues.

Question 38

The owner of a convenience shop 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 $9000 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)$2700
B)$2475
C)$2250
D)$0.00

Question 39

Urban 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 [blank].

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

Question 40

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 41

Depreciation expenses affect capital budgeting analysis by increasing

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

Question 42

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 43

If depreciation expense is taken over five years rather than three 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 44

The machine's NPV is [blank].

A)$1556.56
B)$2556.56
C)$1123.99
D)$2123.99

Question 45

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 46

Jefferson & Co.is considering adding a product line that would utilize floor space in their manufacturing plant which is currently used for storage.Jefferson & Co.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 47

The machine's IRR is

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

Question 48

Which of the following is the first step in calculating project cash flows?

A)Estimating a project's operating cash flows
B)Calculating a project's working capital requirements
C)Calculating a project's capital expenditure requirements
D)Calculating a project's free cash flow

Question 49

If Rite Choice Market 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 50

Blue Ocean Co.purchased a machine for $2,575,000.Required modifications will cost $375,000.Blue Ocean will need to invest $75,000 for additional inventory.The machine has an IRS approved useful life of seven years; it is presumed to have no salvage value.It will only be operated for three years, after which it will be sold for $600,000.Blue Ocean 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 3?

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

Question 51

The initial investment for this decision is [blank].

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

Question 52

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 53

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 54

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 55

Blue Ocean Co.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.Blue Ocean will need to invest $75,000 for additional inventory.The machine has an IRS approved useful life of seven years; it is presumed to have no salvage value.It will only be operated for three 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 56

A firm purchased an asset with a five-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 [blank].

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

Question 57

The machine's after-tax incremental cash flow in year 5 is [blank].

A)$6980
B)$5980
C)$7120
D)$8620

Question 58

Blue Ocean Co.will purchase a machine that will cost $2,575,000.Required modifications will cost $375,000.Blue Ocean will need to invest $75,000 for additional inventory.The machine has an IRS approved useful life of seven years; it is presumed to have no salvage value.Blue Ocean plans to depreciate the machine by using the straight-line method.The machine is expected to increase Blue Ocean'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 59

The machine's incremental after-tax cash inflow for year 1 is [blank].

A)$6420
B)$7980
C)$8620
D)$5980

Question 60

Blue Ocean Co.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.Blue Ocean will need to invest $75,000 for additional inventory.The machine has an IRS approved useful life of seven years; it is presumed to have no salvage value.It will only be operated for three 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 61

Terra Corp 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

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 [blank].

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

Question 63

Slate Corp is considering a new project with the following projections for year 2. Year 2 Projections
Calculate the operating cash flow for year 2.

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

Question 64

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 65

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

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

Question 66

The capital budgeting decision-making process involves estimating the expected incremental cash flows of a proposal and comparing the present value of these cash flows to the project's cost.

Question 67

Which of the following is the last step in calculating project cash flows?

A)Estimating a project's operating cash flows
B)Calculating a project's working capital requirements
C)Calculating a project's capital expenditure requirements
D)Calculating a project's free cash flow

Question 68

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%.How much is the initial cash outlay of the processor?

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

Question 69

P&J expects to own a building for five years, then sell it for $1,500,000 net of taxes, sales commissions and other selling costs.P&J'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 70

The depreciation method used in capital budgeting is irrelevant because any depreciation not taken during the life of the project will add to the book value when assets are sold.

Question 71

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

Question 72

Super Sew 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 $3000 to install it.The embroiderer will save $12,000 in labor expense each year.Super Sew 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 73

Tully's Tool and Die has the following projections for year 1 of a capital budgeting project. Year 1 Incremental Projections:
Calculate the operating cash flow for year 1.

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

Question 74

It is not necessary to consider depreciation in estimating cash flows for a new capital project.

Question 75

Working capital for a project includes investment in fixed assets.

Question 76

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 77

In year 3 of project Gamma sales were $3,000,0000, cost of goods sold was $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%.Calculate operating cash flow for year 3 of project Gamma.

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

Question 78

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

Question 79

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 80

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 $2000 in transportation costs and $4000 for installation.The equipment will have a useful life of five years.The proposal will require that Capital Assets Corp.send a technician for training at a cost of $5000.The firm's marginal tax rate is 40%.How much is the initial cash outlay of the photocopy machine?

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