Question 1

In net present value analysis, the release of working capital at the end of a project should be:
A) ignored.
B) included as a cash outflow.
C) included as a cash inflow.
D) included as a tax deduction.

Accepted Answer

The release of working capital at the end of a project should be included as a cash inflow in the net present value analysis. This is because working capital is considered an investment in the project and its release represents a return of that investment. Therefore, it should be included in the cash inflows of the project.

Question 2

Mester Corporation has provided the following information concerning a capital budgeting project:  The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.
Use Exhibit 7B-1 to determine the appropriate discount factor(s) using table.
The net present value of the project is closest to:
A) $65,640
B) $119,000
C) $171,822
D) $51,822

Accepted Answer

Depreciation expense = (Original cost - Salvage value) ÷ Useful life
= ($120,000 - $0) ÷ 4 years = $30,000 per year 11eacbfc_c80d_b57c_8ffe_2905d5859623_TB7552_00

Question 3

All cash inflows are taxable.

Accepted Answer

Not all cash inflows are taxable. Some examples include gifts, inheritances in many jurisdictions, and certain types of insurance payouts, which may not be subject to income tax.

Question 4

Nakama Corporation is considering investing in a project that would have a 4 year expected useful life. The company would need to invest $280,000 in equipment that will have zero salvage value at the end of the project. Annual incremental sales would be $640,000 and annual cash operating expenses would be $480,000. In year 3 the company would have to incur one-time renovation expenses of $50,000. Working capital in the amount of $20,000 would be required. The working capital would be released for use elsewhere at the end of the project. The company uses straight-line depreciation on all equipment. The company's tax rate is 30%. The income tax expense in year 2:
A) $48,000
B) $12,000
C) $14,500
D) $27,000

Accepted Answer

Depreciation expense = (Original cost - Salvage value) ÷ Useful life
= ($280,000 - $0) ÷ 4 years = $70,000 per year
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Question 5

A company anticipates incremental net income (i.e., incremental taxable income) of $20,000 in year 3 of a project. The company's tax rate is 30% and its after-tax discount rate is 8%. Use Exhibit 7B-1 to determine the appropriate discount factor(s) using table.
The present value of this future cash flow is closest to:
A) $6,000
B) $4,763
C) $14,000
D) $11,116

Accepted Answer

Income tax expense = 0.30 × $20,000 = $6,000
After-tax net cash inflow = $20,000 - $6,000 = $14,000
Present value = 0.794 × $14,000 = $11,116

Question 6

When a company invests in equipment, it is not ordinarily allowed to immediately expense the entire cost of the equipment when computing taxable income.

Accepted Answer

Typically, companies must capitalize the cost of equipment and then depreciate it over the useful life of the asset, rather than expensing the entire cost immediately for tax purposes.

Question 7

Last year the sales at Summit Corporation were $400,000 and were all cash sales. The expenses at Summit were $250,000 and were all cash expenses. The tax rate was 30%. The after-tax net cash inflow at Summit last year was:
A) $150,000
B) $45,000
C) $105,000
D) $400,000

Accepted Answer

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Question 8

In net present value analysis, an investment in equipment at the beginning of a project should be:
A) ignored.
B) included as a cash outflow.
C) included as a cash inflow.
D) included as a tax deduction.

Accepted Answer

Investment in equipment is a cash outflow at the beginning of a project and should be included in the net present value analysis as it affects the overall project cash flows. Ignoring it or including it as a cash inflow or tax deduction will give an incorrect estimate of the project’s financial viability.

Question 9

Depreciation expense is not included in the computation of incremental net income when determining the income tax expense associated with a capital budgeting project.

Accepted Answer

Depreciation expense is a non-cash expense that is subtracted from revenue to determine net income, and it is included in the computation of income tax expense associated with a capital budgeting project.

Question 10

A capital budgeting project's incremental net income computation for purposes of determining incremental tax expense includes investments in working capital.

Accepted Answer

Investments in working capital are not included in the computation of incremental net income for tax purposes because they are considered non-operating cash flows. Incremental net income calculations focus on revenues and expenses directly related to the project's operations.

Question 11

Rhoads Corporation is considering a capital budgeting project that would require an investment of $160,000 in equipment with a 4-year expected life and zero salvage value. Annual incremental sales will be $460,000 and annual incremental cash operating expenses will be $330,000. The company's income tax rate is 30% and the after-tax discount rate is 15%. The company uses straight-line depreciation on all equipment; the annual depreciation expense will be $40,000. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting. Use Exhibit 7B-1 to determine the appropriate discount factor(s) using table.
The net present value of the project is closest to:
A) $178,252
B) $252,000
C) $97,040
D) $134,168

Accepted Answer

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Question 12

Coffie Corporation has provided the following information concerning a capital budgeting project:  The company uses straight-line depreciation on all equipment.
The total cash flow net of income taxes in year 2 is:
A) $90,000
B) $75,000
C) $130,000
D) $103,000

Accepted Answer

Depreciation expense = (Original cost - Salvage value) ÷ Useful life
= ($160,000 - $0) ÷ 4 years = $40,000 per year
 11eacbfc_c80e_2aaf_8ffe_114cee9669be_TB7552_00

Question 13

A company needs an increase in working capital of $50,000 in a project that will last 4 years. The company's tax rate is 30% and its after-tax discount rate is 8%. Use Exhibit 7B-1 to determine the appropriate discount factor(s) using table.
The present value of the release of the working capital at the end of the project is closest to:
A) $36,750
B) $15,000
C) $25,726
D) $35,000

Accepted Answer

Present value = 0.735 × $50,000 = $36,750

Question 14

The following information concerning a proposed capital budgeting project has been provided by Jochum Corporation:  The expected life of the project is 4 years. The income tax rate is 30%. The after-tax discount rate is 9%. The company uses straight-line depreciation on all equipment and the annual depreciation expense would be $70,000. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.
Use Exhibit 7B-1 to determine the appropriate discount factor(s) using table.
The net present value of the project is closest to:
A) $176,900
B) $182,000
C) $84,770
D) $92,770

Accepted Answer

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Question 15

A capital budgeting project's incremental net income computation for purposes of determining incremental tax expense includes immediate cash outflows for initial investments in equipment.

Accepted Answer

Incremental net income computation for tax purposes typically includes revenues and expenses related to operations, not the immediate cash outflows for initial investments in equipment, as these are capitalized and depreciated over time, not expensed immediately.

Question 16

Coache Corporation is considering a capital budgeting project that would require an investment of $120,000 in equipment with a 4 year useful life and zero salvage value. The annual incremental sales would be $310,000 and the annual incremental cash operating expenses would be $230,000. In addition, there would be a one-time renovation expense in year 3 of $30,000. The company's income tax rate is 30%. The company uses straight-line depreciation on all equipment. The total cash flow net of income taxes in year 3 is:
A) $44,000
B) $35,000
C) $65,000
D) $50,000

Accepted Answer

Depreciation expense = (Original cost - Salvage value) ÷ Useful life
= ($120,000 - $0) ÷ 4 years = $30,000 per year
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Question 17

Under the simplifying assumptions made in the text, to calculate the amount of income tax expense associated with an investment project, first calculate the incremental net cash inflow during each year of the project and then multiply each year's incremental net cash inflow by the tax rate.

Accepted Answer

The answer of Under the simplifying assumptions made in the...

Question 18

The investment in working capital at the start of an investment project can be deducted from revenues when computing taxable income.

Accepted Answer

The investment in working capital at the start of an investment project cannot be deducted from revenues when computing taxable income. Instead, it is typically capitalized and depreciated over time as part of the overall project cost.

Question 19

Fontana Corporation is considering a capital budgeting project that would require investing $240,000 in equipment with an expected life of 4 years and zero salvage value. The annual incremental sales would be $640,000 and the annual incremental cash operating expenses would be $440,000. The company's income tax rate is 30%. The company uses straight-line depreciation on all equipment. The total cash flow net of income taxes in year 2 is:
A) $158,000
B) $200,000
C) $88,000
D) $140,000

Accepted Answer

Depreciation expense = (Original cost - Salvage value) ÷ Useful life
= ($240,000 - $0) ÷ 4 years = $60,000 per year
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Question 20

Income taxes have no effect on whether a capital budgeting project should or should not be accepted in a for-profit company.

Accepted Answer

Income taxes can have an impact on the net cash flows of a project and therefore affect the decision to accept or reject a capital budgeting project. This is because taxes are usually treated as an expense, which reduces the cash flows available for investment. Additionally, the tax laws may provide incentives or penalties for certain types of projects, which can further impact the decision-making process.

Quiz 20: Income Taxes and the Net Present Value Method

In net present value analysis, the release of working capital at the end of a project should be: