Deck 12: Analysing Project Cash Flows

Question 1

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.

Answer 1

B

Question 2

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 2

C

Question 3

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

Answer 3

D

Question 4

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

A)A new security system will reduce shoplifting losses by $50,000 per year.
B)New equipment associated with the project will increase depreciation expense by $300,000 per year.
C)Interest on construction loans will increase interest expense by $225,000 per year.
D)The new project will occupy about 5% of the Chief Operating Officer's time,so 5% of her salary should be included.

Question 5

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

Question 6

The calculation of incremental cash flows over a project's useful 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 7

If an investment project would make use of land that the firm currently owns,the project should be charged with

A)a sunk cost.
B)an opportunity cost.
C)amortisation.
D)interest.

Question 8

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 9

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)Cash flows that occur only if the project is taken

Question 10

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

A)Increase in accounts receivable
B)The cost of shipping new equipment
C)The cost of market research already spent on the project
D)The cost of installing new equipment

Question 11

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 12

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)Incremental cash flows over the project's useful life
D)Terminal cash flow

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 best describes why cash flows are utilized rather than accounting profits when evaluating capital projects?

A)Deducting interest expense from income and also including it in the discount rate would result in double counting.
B)Cash flows reflect the timing of benefits and costs more accurately than accounting profits.
C)Cash flows are more stable than accounting profits.
D)Both A and B.

Question 15

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 16

The owner of a convenience store is considering adding a take-away 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 17

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 18

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 19

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 20

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 21

A cash flow analysis can safely ignore any cash flow changes that the project might create elsewhere in the company.

Question 22

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 23

Project cash flows used in the capital budgeting decision include all of the following EXCEPT

A)past research and development costs.
B)depreciation.
C)increase in capital expenditures.
D)changes in working capital.

Question 24

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 smartphone 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 25

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 26

AGL Limited is evaluating the construction of a gas pipeline to bring natural gas from Western New South Wales to Sydney.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 27

AGL Limited is evaluating the construction of a gas pipeline to bring natural gas from Western New South Wales to Sydney.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 28

Brookfield Multiplex 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 29

Victoria Citrus 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 useful life of the project.Should the interest payments be subtracted from the project's incremental cash flows?

Question 30

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

Question 31

In making a capital budgeting decision,we only include the incremental cash flows resulting from the investment decision.

Question 32

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

Question 33

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 34

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

Question 35

Burbank Construction 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 36

Victoria Citrus is evaluating the introduction of a new line of organic juice 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 37

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 38

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 39

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 40

Synergistic effects should be included in the project's cash flow.

Question 41

XYZ,Inc.is considering adding a product line that would utilise floor space in their manufacturing plant that is currently used for storage.XYZ will need to rent new storage space elsewhere.When calculating free cash flows,XYZ management should:

A)Ignore it because it already owns it.
B)Include the cost of the floor space.
C)Add the cost to revenue as a bonus.
D)Calculate the interest expense on the rented space.

Question 42

Use the following information to answer the following question(s).
Delta Inc.is considering the purchase of a new machine that is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually.Due to the sales increase,Delta will need to increase working capital by $1,000 at the beginning of the project.Delta will depreciate the machine using the straight-line method over the project's five-year useful life to a salvage value of zero.The machine's purchase price is $20,000.The firm has a marginal tax rate of 34 percent,and its required rate of return is 12 percent.
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 43

A firm purchased an asset with a 5-year useful 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 44

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 45

Use the following information to answer the following question(s).
Delta Inc.is considering the purchase of a new machine that is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually.Due to the sales increase,Delta will need to increase working capital by $1,000 at the beginning of the project.Delta will depreciate the machine using the straight-line method over the project's five-year useful life to a salvage value of zero.The machine's purchase price is $20,000.The firm has a marginal tax rate of 34 percent,and its required rate of return is 12 percent.
The machine's initial cash outflow is

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

Question 46

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 47

If Woolworths 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 48

Use the following information to answer the following question(s).
Delta Inc.is considering the purchase of a new machine that is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually.Due to the sales increase,Delta will need to increase working capital by $1,000 at the beginning of the project.Delta will depreciate the machine using the straight-line method over the project's five-year useful life to a salvage value of zero.The machine's purchase price is $20,000.The firm has a marginal tax rate of 34 percent,and its required rate of return is 12 percent.
The machine's NPV is

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

Question 49

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)ordinary shares.

Question 50

Use the following information to answer the following question(s).
Delta Inc.is considering the purchase of a new machine that is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually.Due to the sales increase,Delta will need to increase working capital by $1,000 at the beginning of the project.Delta will depreciate the machine using the straight-line method over the project's five-year useful life to a salvage value of zero.The machine's purchase price is $20,000.The firm has a marginal tax rate of 34 percent,and its required rate of return is 12 percent.
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 51

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 a 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 52

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 a 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 53

Which of the following is included in the calculation of the operating cash flow of a plant expansion project?

A)Incremental Revenue
B)Incremental Cost of goods sold
C)Incremental Operating expenses
D)All of the above

Question 54

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 a 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 55

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 56

Use the following information to answer the following question(s).
Delta Inc.is considering the purchase of a new machine that is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually.Due to the sales increase,Delta will need to increase working capital by $1,000 at the beginning of the project.Delta will depreciate the machine using the straight-line method over the project's five-year useful life to a salvage value of zero.The machine's purchase price is $20,000.The firm has a marginal tax rate of 34 percent,and its required rate of return is 12 percent.
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 57

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 58

Depreciation expenses affect capital budgeting analysis by increasing

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

Question 59

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 a 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 60

All else equal,which of the following would decrease after-tax operating cash flows? A decrease in

A)depreciation expense.
B)interest expense.
C)incremental sales.
D)both A and C.

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

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 63

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 64

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

A)$130,000
B)$180,000
C)$230,000
D)$280,000

Question 65

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

Question 66

A project under consideration by Bizet Co.will require the purchase of machinery for $50,000 and additional inventory for $15,000.Accounts receivable will increase by $12,000 and accounts payable by $14,000.Liability insurance will increase by $2,500 per year and utilities expense by $1,500 per year.What is the investment in working capital required by this project?

A)$77,000
B)$41,000
C)$13,000
D)$4,000

Question 67

Wright's Warehouse has the following projections for Year 1 of a capital budgeting project. Year 1 Incremental Projections:
Sales $200,000
Variable Costs $120,000
Fixed Costs $40,000
Depreciation Expense $20,000
Tax Rate 40%
Calculate the operating cash flow for Year 1.

A)$12,000
B)$32,000
C)$52,000
D)$72,000

Question 68

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 69

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 70

If Morgan Tool & Die Co.acquires a new turret lathe,the lathe will cost $80,000,transportation $6,000,installation $7,500.Installing the new lathe will allow Morgan to reduce its finished goods inventory by $10,000.For capital budgeting purposes,the initial investment required for the new lathe is

A)$83,500.
B)$87,500.
C)$93,500.
D)$103,500.

Question 71

Woodstock Inc.expects to own a building for five years,and 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 72

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 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

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 75

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 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

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 78

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

A)Training expense
B)Working capital investments
C)Installation costs of an asset
D)Before-tax selling price of old machine

Question 79

Burr Habit Corporation is considering a new product line.The company currently manufactures several lines of snow skiing apparel.The new products,insulated ski shorts,are expected to generate sales less cost of goods sold of $1 million per year for the next five years.They expect that during this five-year period,they will lose about $250,000 per year in sales less cost of goods sold on their existing lines of longer ski pants as a result of the introduction of the new product line.The new line will require no additional equipment or space in the plant and can be produced in the same manner as the existing apparel products.The new project will,however,require that the company spend an additional $80,000 per year on insurance in case customers sue for frostbite.Also,a new marketing director would be hired to oversee the line at $45,000 per year in salary and benefits.Because of the different construction of the shorts,an increase in inventory of 3,800 would be required initially.If the marginal tax rate is 30%,compute the incremental after tax cash flows per year for years 1-5.

A)$434,500 per year
B)$625,000 per year
C)$187,500 per year
D)$437,500 per year

Question 80

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.