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1. Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the
easiest step in the capital budgeting process.
a. True
b. False
2. Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting
process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate
estimate of projects' cash flows.
a. True
b. False
3. 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
4. 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
5. 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
6. If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be
included in the analysis.
a. True
b. False
7. Any cash flows that can be classified as incremental to a particular project—i.e., results directly from the decision to
undertake the project—should be reflected in the capital budgeting analysis.
a. True
b. False
8. We can identify the cash costs and cash inflows to a company that will result from a project. These could be called
"direct inflows and outflows," and the net difference is the direct net cash flow. If there are other costs and benefits that do
not flow from or to the firm, but to other parties, these are called externalities, and they need not be considered as a part of
the capital budgeting analysis.
a. True
b. False
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9. In cash flow estimation, the existence of externalities should be taken into account if those externalities have any effects
on the firm's long-run cash flows.
a. True
b. False
10. Suppose a firm's CFO thinks that an externality is present in a project, but that it cannot be quantified with any
precision—estimates of its effect would really just be guesses. In this case, the externality should be ignored—i.e., not
considered at all—because if it were considered it would make the analysis appear more precise than it really is.
a. True
b. False
11. Changes in net operating working capital should not be reflected in a capital budgeting cash flow analysis because
capital budgeting relates to fixed assets, not working capital.
a. True
b. False
12. The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation
the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater.
a. True
b. False
13. 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
14. Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation. This is
because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things held
constant.
a. True
b. False
15. A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if
it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.
a. True
b. False
16. Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward, thus
increasing their present value. On the other hand, using accelerated depreciation generally lowers the reported current
year's profits because of the higher depreciation expenses. However, the reported profits problem can be solved by using
different depreciation methods for tax and stockholder reporting purposes.
a. True
b. False
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17. If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate
risk-adjusted discount rate.
a. True
b. False
18. Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can
overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions for capital
budgeting projects.
a. True
b. False
19. It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several
years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow
analysis.
a. True
b. False
20. The two cardinal rules that financial analysts should follow to avoid errors are: (1) in the NPV equation, the numerator
should use income calculated in accordance with generally accepted accounting principles, and (2) all incremental cash
flows should be considered when making accept/reject decisions for capital budgeting projects.
a. True
b. False
21. 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
22. 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
23. The change in net operating working capital associated with new projects is always positive, because new projects
mean that more operating working capital will be required.
a. True
b. False
24. The use of accelerated versus straight-line depreciation causes net income reported to stockholders to be lower, and
cash flows higher, during every year of a project's life, other things held constant.
a. True
b. False
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25. Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR) is affected
by a small change in one of the input variables, say sales. Other things held constant, with the size of the independent
variable graphed on the horizontal axis and the NPV on the vertical axis, the steeper the graph of the relationship line, the
more risky the project, other things held constant.
a. True
b. False
26. Replacement chain or EAA analysis is required when analyzing projects that have different lives. This is true
regardless of whether the projects are mutually exclusive or independent of one another.
a. True
b. False
27. Although the replacement chain approach is appealing for dealing with mutually exclusive projects that have different
lives, it is not used in practice because not projects meet the assumptions the method requires.
a. True
b. False
MIDTERM EXAM
28. Extending the lives of projects with different lives out to a common life for comparison purposes, while theoretically
appealing, is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their
initial lives.
a. True
b. False
29. The two methods discussed in the text for dealing with unequal project lives are (1) the replacement chain approach
and (2) the equivalent annual annuity (EAA) approach.
a. True
b. False
30. The two methods discussed in the text for dealing with unequal project lives are (1) the replacement chain approach
and (2) the present value approach.
a. True
b. False
31. 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 operating working capital.
b. Shipping and installation costs for machinery acquired.
c. Cannibalization effects.
d. Opportunity costs.
e. Sunk costs that have been expensed for tax purposes.
32. The relative risk of a proposed project is best accounted for by which of the following procedures?
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a. Adjusting the discount rate upward if the project is judged to have above-average risk.
b. Adjusting the discount rate upward if the project is judged to have below-average risk.
c. Reducing the NPV by 10% for risky projects.
d. Picking a risk factor equal to the average discount rate.
e. Ignoring risk because project risk cannot be measured accurately.
33. Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for
above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the
company uses the NPV method when choosing projects?
a. Project A, which has average risk and an IRR = 9%.
b. Project B, which has below-average risk and an IRR = 8.5%.
c. Project C, which has above-average risk and an IRR = 11%.
d. Without information about the projects' NPVs we cannot determine which one or ones should be accepted.
e. All of these projects should be accepted as they will produce a positive NPV.
42. Other things held constant, which of the following would increase the NPV of a project being considered?
a. A shift from straight-line to MACRS depreciation.
b. Making the initial investment in the first year rather than spreading it over the first three
years.
c. An increase in the discount rate associated with the project.
d. An increase in required net operating working capital.
e. The project would decrease sales of another product line.
43. A company is considering a new project. The CFO plans to calculate the project's NPV by estimating the relevant cash
flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal
cash flows), then discounting those cash flows at the company's overall WACC. Which one of the following factors
should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?
a. All sunk costs that have been incurred relating to the project.
b. All interest expenses on debt used to help finance the project.
c. The additional investment in net operating working capital required to operate the project, even if that
investment will be recovered at the end of the project's life.
d. Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the
current year.
e. Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash
flows.
44. 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 additional net operating working capital required to operate the project.
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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.
45. When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:
a. Changes in net operating 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.
46. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward
with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear—there
is no mortgage on it. Which of the following statements is CORRECT?
a. Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it
should not be reflected in the cash flows of the capital budgeting analysis for any new project.
b. If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be
charged as a cost to any new project that would use it.
c. This is an example of an externality, because the very existence of the building affects the cash flows for any
new project that Rowell might consider.
d. Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new
projects are being evaluated, even if it would be used by those new projects.
e. If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new
project that used the building.
47. Which of the following should be considered when a company estimates the cash flows used to analyze a proposed
project?
a. The new project is expected to reduce sales of one of the company's existing products by 5%.
b. Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a
portion of her salary for that year should be charged to the project's initial cost.
c. The company has spent and expensed $1 million on research and development costs associated with the new
project.
d. The company spent and expensed $10 million on a marketing study before its current analysis regarding
whether to accept or reject the project.
e. The firm would borrow all the money used to finance the new project, and the interest on this debt would be
$1.5 million per year.
48. Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which
of the following items should NOT be explicitly considered when cash flows are estimated?
a. The company will produce the new product in a vacant building that was used to produce another product until
last year. The building could be sold, leased to another company, or used in the future to produce another of
the firm's products.
b. The project will utilize some equipment the company currently owns but is not now using. A used equipment
dealer has offered to buy the equipment.
c. The company has spent and expensed for tax purposes $3 million on research related to the new product.
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These funds cannot be recovered, but the research may benefit other projects that might be proposed in the
future.
d. The new product will cut into sales of some of the firm's other products.
e. If the project is accepted, the company must invest an additional $2 million in net operating working capital.
However, all of these funds will be recovered at the end of the project's life.
51. Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the
capital budgeting analysis for a new product?
a. A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural
purposes.
b. A new product will generate new sales, but some of those new sales will be from customers who switch from
one of the firm's current products.
c. A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the
new machinery.
d. A firm has spent $2 million on research and development associated with a new product. These costs have
been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is
accepted or rejected.
e. A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's
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other products.
52. Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the
capital budgeting analysis for a new product?
a. Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new
product. This space could be used for other products if it is not used for the project under consideration.
b. Revenues from an existing product would be lost as a result of customers switching to the new product.
c. Shipping and installation costs associated with a machine that would be used to produce the new product.
d. The cost of a study relating to the market for the new product that was completed last year. The results of this
research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the
research was incurred and expensed for tax purposes last year.
e. It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to
another firm.
53. A company is considering a proposed new plant that would increase productive capacity. Which of the following
statements is CORRECT?
a. In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest
expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted
when estimating cash flows, this would, in effect, "double count" it.
b. Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating
the operating cash flows.
c. When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk
costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the
discounting process.
d. Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a
before-tax basis.
e. The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax
basis. To do otherwise would bias the NPV upward.
54. Taussig Technologies is considering two potential projects, X and Y. In assessing the projects' risks, the company
estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted
thorough scenario and simulation analyses. This research produced the following data:
Project X Project Y
Expected NPV $350,000 $350,000
Standard deviation (σNPV) $100,000 $150,000
Project beta (vs. market) 1.4 0.8
Correlation of the project cash Cash flows are not correlated Cash flows are highly correlated
flows with cash flows from with the cash flows from with the cash flows from
currently existing projects existing projects existing projects
FINAL EXAM
55. Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall
economy. The company estimates that a proposed new project would have a higher standard deviation and coefficient of
variation than an average company project. Also, the new project's sales would be countercyclical in the sense that they
would be high when the overall economy is down and low when the overall economy is strong. On the basis of this
information, which of the following statements is CORRECT?
a. The proposed new project would have more stand-alone risk than the firm's typical project.
b. The proposed new project would increase the firm's corporate risk.
c. The proposed new project would increase the firm's market risk.
d. The proposed new project would not affect the firm's risk at all.
e. The proposed new project would have less stand-alone risk than the firm's typical project.
56. A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all
methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the
following?
a. Increase the estimated IRR of the project to reflect its greater risk.
b. Increase the estimated NPV of the project to reflect its greater risk.
c. Reject the project, since its acceptance would increase the firm's risk.
d. Ignore the risk differential if the project would amount to only a small fraction of the firm's total
assets.
e. Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
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e. As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to
be used than sensitivity analysis.
60. Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated
depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce
a. Higher depreciation charges in the early years of an asset's life.
b. Larger cash flows in the earlier years of an asset's life.
c. Larger total undiscounted profits from the project over the project's life.
d. Smaller accounting profits in the early years, assuming the company uses the same depreciation method for
tax and book purposes.
e. Lower tax payments in the earlier years of an asset's life.
61. 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
62. Your company, RMU Inc., is considering a new project whose data are shown below. What is the project's Year 1
cash flow?
Sales revenues $22,250
Depreciation $8,000
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Other operating costs $12,000
Tax rate 35.0%
a. $ 8,903
b. $ 9,179
c. $ 9,463
d. $ 9,746
e. $10,039
63. 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. depreciation) $25,000
Tax rate 35.0%
a. $28,115
b. $28,836
c. $29,575
d. $30,333
e. $31,092
64. As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with
the following data. What is the Year 1 cash flow?
Sales revenues, each year $42,500
Depreciation $10,000
Other operating costs $17,000
Interest expense $4,000
Tax rate 35.0%
a. $16,351
b. $17,212
c. $18,118
d. $19,071
e. $20,075
65. You work for Whittenerg Inc., which is considering a new project whose data are shown below. What is the project's
Year 1 cash flow?
Sales revenues, each year $62,500
Depreciation $8,000
Other operating costs $25,000
Interest expense $8,000
Tax rate 35.0%
a. $25,816
b. $27,175
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c. $28,534
d. $29,960
e. $31,458
66. Fool Proof Software is considering a new project whose data are shown below. The equipment that would be used has
a 3-year tax life, and the allowed depreciation rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4.
Revenues and other operating costs are expected to be constant over the project's 10-year expected life. What is the Year 1
cash flow?
Equipment cost (depreciable basis) $65,000
Sales revenues, each year $60,000
Operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $30,258
b. $31,770
c. $33,359
d. $35,027
e. $36,778
67. Your company, CSUS Inc., is considering a new project whose data are shown below. The required equipment has a
3-year tax life, and the accelerated rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues
and other operating costs are expected to be constant over the project's 10-year expected operating life. What is the
project's Year 4 cash flow?
Equipment cost (depreciable basis) $70,000
Sales revenues, each year $42,500
Operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $11,814
b. $12,436
c. $13,090
d. $13,745
e. $14,432
68. 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 change in net operating 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 depreciation rate 33.3333%
Sales revenues, each year $65,500
Annual operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $15,740
b. $16,569
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c. $17,441
d. $18,359
e. $19,325
69. Liberty Services is now at the end of the final year of a project. The equipment originally cost $22,500, of which 75%
has been depreciated. The firm can sell the used equipment today for $6,000, and its tax rate is 40%. What is the
equipment's after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment's final market value
is less than its book value, the firm will receive a tax credit as a result of the sale.
a. $5,558
b. $5,850
c. $6,143
d. $6,450
e. $6,772
70. 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 depreciation rates below. 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
71. Mulroney Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0.
Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $7,800 at the end of Years 1 and 2,
respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has
an expected life of 4 years with after-tax cash inflows of $4,300 at the end of each of the next 4 years. Each project has a
WACC of 8%. Using the replacement chain approach, what is the NPV of the most profitable project?
a. $4,242
b. $4,246
c. $4,286
d. $4,325
e. $4,433
72. Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0.
Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,500 at the end of Years 1 and 2,
respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has
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an expected life of 4 years with after-tax cash inflows of $4,600 at the end of each of the next 4 years. Each project has a
WACC of 11%. What is the equivalent annual annuity of the most profitable project?
a. $1,345.50
b. $1,346.30
c. $1,361.52
d. $1,376.74
e. $1,411.15
73. Carlyle Inc. is considering two mutually exclusive projects. Both require an initial investment of $15,000 at t = 0.
Project S has an expected life of 2 years with after-tax cash inflows of $7,000 and $12,000 at the end of Years 1 and 2,
respectively. In addition, Project S can be repeated at the end of Year 2 with no changes in its cash flows. Project L has
an expected life of 4 years. Each project has a WACC of 9%. What is the equivalent annual annuity of the most
profitable project?
a. $569.67
b. $792.34
c. $865.31
d. $1,522.18
e. $1,846.54
74. TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be
depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net
operating working capital would be required. Revenues and other operating costs are expected to be constant over the
project's 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax
annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1–3.)
WACC 10.0%
Pre-tax cash flow reduction for other products (cannibalization) −$5,000
Investment cost (depreciable basis) $80,000
Straight-line depreciation rate 33.333%
Annual sales revenues $67,500
Annual operating costs (excl. depreciation) −$25,000
Tax rate 35.0%
a. $3,636
b. $3,828
c. $4,019
d. $4,220
e. $4,431
75. Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns
the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The
equipment for the project would be depreciated by the straight-line method over the project's 3-year life, after which it
would be worth nothing and thus it would have a zero salvage value. No change in net operating working capital would be
required, and revenues and other operating costs would be constant over the project's 3-year life. What is the project's
NPV? (Hint: Cash flows are constant in Years 1–3.)
WACC 10.0%
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Opportunity cost $100,000
Net equipment cost (depreciable basis) $65,000
Straight-line depreciation rate for equipment 33.333%
Annual sales revenues $123,000
Annual operating costs (excl. depreciation) $25,000
Tax rate 35%
a. $10,521
b. $11,075
c. $11,658
d. $12,271
e. $12,885
76. Atlas Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0.
Project S has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at the end of Years 1 and 2,
respectively. Project L has an expected life of 4 years with after-tax cash inflows of $4,373 at the end of each of the next
4 years. Each project has a WACC of 9.25%, and Project S can be repeated with no changes in its cash flows. The
controller prefers Project S, but the CFO prefers Project L. How much value will the firm gain or lose if Project L is
selected over Project S, i.e., what is the value of NPVL - NPVS?
a. $56.50
b. $62.15
c. $68.37
d. $75.21
e. $82.73
77. Desai Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be
constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise
with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no
salvage value. No change in net operating working capital would be required. This is just one of many projects for the
firm, so any losses on this project can be used to offset gains on other firm projects. What is the project's expected NPV?
WACC 10.0%
Net investment cost (depreciable basis) $200,000
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed oper. costs excl. depreciation (constant) $150,000
Variable oper. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation rate per year 5.00%
Tax rate 40.0%
a. $15,925
b. $16,764
c. $17,646
d. $18,528
e. $19,455
78. Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be
constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise
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with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no
salvage value. No change in net operating working capital would be required. This is just one of many projects for the
firm, so any losses on this project can be used to offset gains on other firm projects. The marketing manager does not
think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the
CFO thinks an inflation adjustment is required. What is the difference in the expected NPV if the inflation adjustment is
made versus if it is not made?
WACC 10.0%
Net investment cost (depreciable basis) $200,000
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed oper. costs excl. depreciation (constant) $150,000
Variable oper. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation 4.00%
Tax rate 40.0%
a. $12,018
b. $12,650
c. $13,316
d. $13,982
e. $14,681
79. 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 additional net
operating 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 from operations are constant
in Years 1 to 3.)
WACC 10.0%
Net investment in fixed assets (basis) $75,000
Required net operating working capital $15,000
Straight-line depreciation rate 33.333%
Annual sales revenues $75,000
Annual operating costs (excl. depreciation) $25,000
Tax rate 35.0%
a. $23,852
b. $25,045
c. $26,297
d. $27,612
e. $28,993
80. Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life
and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value
at the end of Year 3, when the project would be closed down. Also, additional net operating working capital would be
required, but it 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 3-year life. What is the project's NPV?
WACC 10.0%
Net investment in fixed assets (depreciable basis) $70,000
Required net operating working capital $10,000
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Straight-line depreciation rate 33.333%
Annual sales revenues $75,000
Annual operating costs (excl. depreciation) $30,000
Expected pre-tax salvage value $5,000
Tax rate 35.0%
a. $20,762
b. $21,854
c. $23,005
d. $24,155
e. $25,363
81. Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year
tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value
after Year 3. No change in net operating working capital would be required. Revenues and other operating costs will be
constant over the project's life, and this is just one of the firm's many projects, so any losses on it can be used to offset
profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the
project's NPV change? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)
WACC 10.0%
Net investment cost (depreciable basis) $60,000
Number of cars washed 2,800
Average price per car $25.00
Fixed oper. costs (excl. depreciation) $10,000
Variable oper. cost/unit (i.e., VC per car washed) $5.375
Annual depreciation $20,000
Tax rate 35.0%
a. −$28,939
b. −$30,462
c. −$32,066
d. −$33,753
e. −$35,530
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