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Question;CHAPTER;12 ? Practice Problems;CASH FLOW ESTIMATION AND RISK ANALYSIS;(12-1) Cash flow estimation;1. Although it is;extremely difficult to make accurate forecasts of the revenues that a project;will generate, projects' initial outlays and subsequent costs can be forecasted;with great accuracy. This is especially;true for large product development projects.;a. True;b. False;(12-1) Relevant cash flows;2. Since the focus of;capital budgeting is on cash flows rather than on net income, changes in;noncash balance sheet accounts such as inventory are not included in a capital;budgeting analysis.;a. True;b. False;(12-1) Relevant cash flows;3. If an investment;project would make use of land which the firm currently owns, the project;should be charged with the opportunity cost of the land.;a. True;b. False;(12-2) Depreciation cash flows;4. The primary advantage;to using accelerated rather than straight-line depreciation is that with;accelerated depreciation the present value of the tax savings provided;by depreciation will be higher, other things held constant.;a. True;b. False;(12-1) Opportunity costs;5. Opportunity costs;include those cash inflows that could be generated from assets the firm already;owns if those assets are not used for the project being evaluated.;a. True;b. False;(12-1) Sunk costs;6. Suppose Walker;Publishing Company is considering bringing out a new finance text whose;projected revenues include some revenues that will be taken away from another;of Walker's books. The lost sales on the;older book are a sunk cost and as such should not be considered in the analysis;for the new book.;a. True;b. False;(12-1) Cash flow issues;7. Which of the;following is NOT a;relevant cash flow and thus should not be reflected in the analysis of a;capital budgeting project?;a. Changes in net working capital.;b. Shipping and installation costs.;c. Cannibalization effects.;d. Opportunity costs.;e. Sunk costs that have been expensed for tax;purposes.;(12-1) Sunk costs;8. Which of the;following statements is CORRECT?;a. A sunk cost is any cost that must be expended;in order to complete a project and bring it into operation.;b. A sunk cost is any cost that was expended in;the past but can be recovered if the firm decides not to go forward with the;project.;c. A sunk cost is a cost that was incurred and;expensed in the past and cannot be recovered if the firm decides not to go;forward with the project.;d. Sunk costs were formerly hard to deal with, but;once the NPV method came into wide use, it became possible to simply include;sunk costs in the cash flows and then calculate the PV.;e. A good example of a sunk cost is a situation;where Home Depot opens a new store, and that leads to a decline in sales of one;of the firm?s existing stores.;(12-2) Depreciation;9. Which of the;following statements is CORRECT?;a. Using accelerated depreciation rather than;straight line would normally have no effect on a project?s total projected cash;flows but it would affect the timing of the cash flows and thus the NPV.;b. Under current laws and regulations;corporations must use straight-line depreciation for all assets whose lives are;5 years or longer.;c. Corporations must use the same depreciation;method (e.g., straight line or accelerated) for stockholder reporting and tax;purposes.;d. Since depreciation is not a cash expense, it;has no effect on cash flows and thus no effect on capital budgeting decisions.;e. Under accelerated depreciation, higher;depreciation charges occur in the early years, and this reduces the early cash;flows and thus lowers a project's projected NPV.;(12-1) Relevant cash flows C I K;10. Which of the;following factors should be included in the cash flows used to estimate;a project?s NPV?;a. All costs associated with the project that have;been incurred prior to the time the analysis is being conducted.;b. Interest on funds borrowed to help finance the;project.;c. The end-of-project recovery of any working;capital required to operate the project.;d. Cannibalization effects, but only if those;effects increase the project?s projected cash flows.;e. Expenditures to date on research and;development related to the project, provided those costs have already been;expensed for tax purposes.;(12-1) Relevant cash flow;11. When evaluating a new;project, firms should include in the projected cash flows all of the following EXCEPT;a. Changes in net working capital attributable to;the project.;b. Previous expenditures associated with a market;test to determine the feasibility of the project, provided those costs have;been expensed for tax purposes.;c. The value of a building owned by the firm that;will be used for this project.;d. A decline in the sales of an existing product;provided that decline is directly attributable to this project.;e. The salvage value of assets used for the;project that will be recovered at the end of the project?s life.;(12-1) Externalities;12. Which of the;following statements is CORRECT?;a. An externality is a situation where a project;would have an adverse effect on some other part of the firm?s overall;operations. If the project would have a favorable;effect on other operations, then this is not an externality.;b. An example of an externality is a situation;where a bank opens a new office, and that new office causes deposits in the;bank?s other offices to increase.;c. The NPV method automatically deals correctly;with externalities, even if the externalities are not specifically identified;but the IRR method does not. This is;another reason to favor the NPV.;d. Both the NPV and IRR methods deal correctly;with externalities, even if the externalities are not specifically;identified. However, the payback method;does not.;e. Identifying an externality can never lead to an;increase in the calculated NPV.;(12-2) Annual CF;13. As assistant to the;CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with;the following data. What is the Year 1;cash flow?;Sales revenues $13,000;Depreciation $4,000;Other operating costs $6,000;Tax rate 35.0%;a. $5,950;b. $6,099;c. $6,251;d. $6,407;e. $6,568;(12-2) Annual CF;14. Clemson Software is;considering a new project whose data are shown below. The required equipment has a 3-year tax life;after which it will be worthless, and it will be depreciated by the;straight-line method over 3 years.;Revenues and other operating costs are expected to be constant over the;project's 3-year life. What is the;project's Year 1 cash flow?;Equipment cost (depreciable basis) $65,000;Straight-line depreciation rate 33.333%;Sales revenues, each year $60,000;Operating costs (excl. deprec.) $25,000;Tax rate 35.0%;a. $28,115;b. $28,836;c. $29,575;d. $30,333;e. $31,092;(12-2) Project NPV;15. Temple Corp. is;considering a new project whose data are shown below. The equipment that would be used has a 3-year;tax life, would be depreciated by the straight-line method over its 3-year;life, and would have a zero salvage value.;No new working capital would be required. Revenues and other operating costs are;expected to be constant over the project's 3-year life. What is the project's NPV?;Risk-adjusted WACC 10.0%;Net investment cost (depreciable basis) $65,000;Straight-line deprec. rate 33.3333%;Sales revenues, each year $65,500;Operating costs (excl. deprec.), each year $25,000;Tax rate 35.0%;a. $15,740;b. $16,569;c. $17,441;d. $18,359;e. $19,325;(12-2) Salvage value;16. Marshall-Miller;Company is considering the purchase of a new machine for $50,000;installed. The machine has a tax life of;5 years, and it can be depreciated according to the following rates. The firm expects to operate the machine for 4;years and then to sell it for $12,500.;If the marginal tax rate is 40%, what will the after-tax salvage value;be when the machine is sold at the end of Year 4?;Year Depreciation;Rate;1 0.20;2 0.32;3 0.19;4 0.12;5 0.11;6 0.06;a. $8,878;b. $9,345;c. $9,837;d. $10,355;e. $10,900;(12-2) Project NPV;17. Foley Systems is considering;a new investment whose data are shown below.;The equipment would be depreciated on a straight-line basis over the;project's 3-year life, would have a zero salvage value, and would require some;additional working capital that would be recovered at the end of the project's;life. Revenues and other operating costs;are expected to be constant over the project's life. What is the project's NPV? (Hint: Cash flows are constant in Years 1 to;3.);WACC 10.0%;Net investment in fixed assets;(basis) $75,000;Required new working capital $15,000;Straight-line deprec. rate 33.333%;Sales revenues, each year $75,000;Operating costs (excl. deprec.);each year $25,000;Tax rate 35.0%;a. $23,852;b. $25,045;c. $26,297;d. $27,612;e. $28,993;Solutions to Problem 17;[1]7. (12-2);Project npv;t = 0 t;= 1 t = 2 t = 3;Investment in fixed;assets WACC = 10% -$75,000;Investment in net;working capital -$15,000;Sales revenues $75,000 $75,000 $75,000;- Operating costs (excl. deprec.) 25,000 25,000 25,000;Depreciation Rate = 33.333%;25,000 25,000 25,000;Operating income;(EBIT) $25,000 $25,000 $25,000;-;Taxes Rate;= 35% 8,750 8,750 8,750;After-tax EBIT $16,250 $16,250 $16,250;+;Depreciation 25,000;25,000 25,000;Cash flow from;operations -$90,000 $41,250 $41,250 $41,250;Recovery of working;capital;15,000;Total cash flows -$90,000 $41,250 $41,250 $56,250;NPV $23,852

 

Paper#44730 | Written in 18-Jul-2015

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