Question 1

Uptown Motors is analyzing a project with annual sales of $420,000,straight-line depreciation of $28,700 a year,and a net working capital requirement of $34,000.The firm has a tax rate of 34 percent and a profit margin of 6.1 percent.The firm has no long-term debt.What is the amount of the operating cash flow?

Accepted Answer

OCF = ($420,000 × 0.061)+ $28,700 = $54,320

Question 2

The Market is considering a project that will require the purchase of $1.27 million in new equipment.The equipment will be depreciated straight-line to zero over the 6-year life of the project.What is the value of the depreciation tax shield in Year 2 of the project if the tax rate is 35 percent?

Accepted Answer

Depreciation tax shield = ($1,270,000 / 6)× 0.35 = $74,083.33

Question 3

Outdoor Gear is purchasing equipment costing $485,900 that will lower manufacturing costs by $132,000 a year.The equipment will be depreciated over 8 years using straight-line depreciation to a zero book value.After 8 years,the equipment will be worthless.The discount rate is 16 percent and the tax rate is 34 percent.What is the annual net income from this purchase?

Accepted Answer

Annual depreciation = $485,900 / 8 = $60,737.50
Net income = ($132,000 − $60,737.50)× (1 - 0.34)= $47,033.25

Question 4

The initial cost of a machine is $727,000 with annual operating costs of $39,600.Each machine has a life of 5 years before it is replaced.Ignore taxes.What is the equivalent annual cost of this machine if the required return is 16 percent?

Accepted Answer

PV_Costs = $727,000 + $39,600[(1 − 1 / 1.16⁵)/ 0.16] = $856,662.03 $856,662.03 = EAC[(1 − 1 / 1.16⁵)/ 0.16] EAC = $261,632.62

Question 5

Thornley Co.is considering a 3-year project with an initial cost of $636,000.The equipment is classified as MACRS 7-year property.The MACRS table values are 0.1429,0.2449,0.1749,0.1249,0.0893,0.0892,0.0893,and 0.0446 for Years 1 to 8,respectively.At the end of the project,the equipment will be sold for an estimated $279,000.The tax rate is 35 percent,and the required return is 17 percent.An extra $23,000 of inventory will be required for the life of the project.Annual sales are estimated at $379,000 with costs of $247,000.What is the total cash flow for Year 3?

Accepted Answer

Depreciation_Year ₃ = $636,000 × 0.1749 = $111,236.40 OCF₃ = ($379,000 − $247,000 − $111,236.40)(1 − 0.35)= $13,496.34 Book Value_Year ₃ = $636,000 × (1 − 0.1429 − 0.2449 − 0.1749)= $278,122.80 After-tax salvage value = $279,000 − 0.35($279,000 − $278,122.80)= $278,692.98 C0₃ = $13,496.34 + $23,000 + $278,692.98 = $315,189.32

Question 6

Margarite's Enterprises is considering a new 5-year project that will require $612,000 for new fixed assets,$160,000 for inventory,and $35,000 for accounts receivable.Short-term debt is expected to increase by $110,000.The fixed assets will be depreciated straight-line to zero over the life of the project.The project is expected to generate annual sales of $694,000 with costs of $428,000.The tax rate is 35 percent,and the required rate of return is 15 percent.What is the amount of the earnings before interest and taxes (EBIT)for the first year of this project?

Accepted Answer

EBIT = $694,000 − $428,000 − ($612,000 / 5)= $143,600

Question 7

Kurt's Kabinets is looking at a 4-year project that will require $76,000 in fixed assets and another $20,000 in net working capital.Annual sales are projected at $142,800 with costs of $79,600.The company uses straight-line depreciation to a zero book value over the life of the project.The tax rate is 35 percent.What is the annual operating cash flow for this project?

Accepted Answer

OCF = ($142,800 − $79,600)(1 − 0.35)+ ($76,000 / 4)(0.35)= $47,730

Question 8

Kay's Quilts is considering a project that will reduce inventory by $38,000,increase accounts payable by $55,000,and increase accounts receivables by 9 percent.Accounts receivable is currently $78,000.What is the cash flow at Time 0 for net working capital?

Accepted Answer

CFO = $38,000 + $55,000 − ($78,000 × 0.09)= $85,900

Question 9

A proposed project will require $410,000 in fixed assets that would be depreciated straight-line to zero over the 3-year life of the project.These assets have an expected aftertax salvage value of $110,000 at the end of the project. The project would require $48,000 of net working capital,all of which is recoverable,along with $220,000 in annual expenses.What is the minimum annual price you should bid on this project if you require a rate of return of 17 percent and have a tax rate of 30 percent?

Accepted Answer

NPV = 0 = -$410,000 - 48,000 + OCF[(1 - 1 / 1.17³)/ 0.17] + ($110,000 + 48,000)/ 1.17³ OCF = $162,632.10 $162,632.10 = (Sales - $220,000)(1 - 0.30)+ ($410,000 / 3)(0.30) Sales = $393,760.15,or $393,760 The minimum annual price that should be bid is $393,760 based on the required return of 17 percent

Question 10

Assume a machine costs $129,000 and lasts 3 years before it is replaced.The operating cost is $7,200 a year.Ignore taxes.What is the equivalent annual cost if the required rate of return is 14 percent?

Accepted Answer

PV_Costs = $129,000 + $7,200[(1 − 1 / 1.14³)/ 0.14] = $145,715.75 $145,715.75 = EAC[(1 − 1 / 1.14³)/ 0.14] EAC = $62,764.36

Question 11

DeCento's is analyzing two mutually exclusive machines to determine which one it should purchase.Whichever machine is purchased,it will be replaced at the end of its useful life.The company requires a return of 15 percent and uses straight-line depreciation to a zero book value over the life of the machine.Machine A has a cost of $386,000,annual operating costs of $29,000,and life of 4 years.Machine B costs $257,000,has annual operating costs of $19,000,and a life of 3 years.The firm currently pays no taxes.Which machine should be purchased and why?

Accepted Answer

PV_Cost, _A = $386,000 + $29,000[(1 − 1 / 1.15⁴)/ 0.15] = $468,794.37 $468,794.37 = EAC[(1 − 1 / 1.15⁴)/ 0.15] EAC = $164,202.43 PV_Cost, _B = $257,000 + $19,000[(1 − 1 / 1.15³)/ 0.15] = $300,381.28 $300,318.28 = EAC[(1 − 1 / 1.15³)/ 0.15] EAC = $131,560.08 Difference in EAC_A-B = $164,202.43 − $131,560.08 = $32,642.35 Machine B has the lower equivalent annual cost,so it should be purchased.

Question 12

Ernie's Electrical is evaluating a project that will increase sales by $48,000 and costs by $16,000.The project will initially cost $89,000 for fixed assets that will be depreciated straight-line to a zero book value over the 6-year life of the project.The applicable tax rate is 34 percent.What is the project's annual operating cash flow?

Accepted Answer

OCF = ($48,000 − $16,000)(1 − 0.34)+ ($89,000 / 6)(0.34)= $26,163.33

Question 13

A project will increase sales by $92,800 and cash expenses by $53,200.The project will cost $89,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project.The tax rate is 35 percent.What is the operating cash flow of the project using the tax shield approach?

Accepted Answer

OCF = [($92,800 − $53,200)× (1 − 0.35)] + [($89,000 / 4)× 0.35] = $33,527.50

Question 14

JADO Mfg.is trying to decide which one of two machines to purchase.Machine A costs $398,000,has a 5-year life and requires $113,000 in pretax annual operating costs.Machine B costs $510,000,has a 4-year life and requires $67,000 in pretax annual operating costs.Either machine will be depreciated using the straight-line method to zero over its life.Neither machine will have any salvage value.Whichever machine is selected,it will never be replaced.The discount rate is 12 percent and the tax rate is 34 percent.Which machine should be purchased and why?

Accepted Answer

OCF_A = −$113,000(1 − 0.34)+ ($398,000 / 5)(0.34)= −$47,516 NPV_A = −$398,000 − $47,516[(1 − 1 / 1.12⁵)/ 0.12] = −$569,284.55 OCF_B =−$67,000(1 − 0.34)+ ($510,000 / 4)(0.34)= −$870 NPV_B = −$510,000 − $870[(1 − 1 / 1.124) /0.12] = −$512,642.49 Difference_{A −B} = −$569,284.55 − (−$512,642.49)= −$56,642.06 Since the machine will not be replaced,Machine B should be purchased because it has the higher (less negative)NPV.

Question 15

Peter's Boats has sales of $711,000 and a profit margin of 7.8 percent.The annual depreciation expense is $59,000.The tax rate is 35 percent.What is the amount of the operating cash flow if the company has no long-term debt?

Accepted Answer

OCF = ($711,000 × 0.078)+ $59,000 = $114,458

Question 16

A project will increase annual sales by $183,000 and cash expenses by $99,000 for 4 years.The project has an initial cost of $115,000 for equipment that will be depreciated using MACRS depreciation.The applicable MACRS table values are 0.1429,0.2449,0.1749,and 0.1249 for Years 1 to 4,respectively.The company has a marginal tax rate of 35 percent.What is the depreciation tax shield for Year 3?

Accepted Answer

Depreciation tax shield_Year ₃ = $115,000 × 0.1749 × 0.35 = $7,039.73

Question 17

Precision Mfg.is trying to decide which one of two machines to purchase.Machine A costs $854,000,has a life of 8 years,and requires $147,000 in pretax annual operating costs.Machine B costs $798,000,has a life of 11 years,and requires $104,000 in pretax annual operating costs.Either machine will be depreciated using the straight-line method to zero over its life.Neither machine will have any salvage value.Whichever machine is selected,it will never be replaced.The discount rate is 13 percent and the tax rate is 35 percent.Which machine should be purchased and why?

Accepted Answer

OCF_A = −$147,000(1 − 0.35)+ ($854,000 / 8)(0.35)= −$58,187.50 NPV_A = −$854,000 − $58,187.50[(1 − 1 / 1.13⁸)/ 0.13] = −$1,133,228.45 OCF_B =−$104,000(1 − 0.35)+ ($798,000 / 11)(0.35)=−$42,209.09 NPV_B = −$798,000 − $42,209.09[(1 − 1 / 1.13¹¹)/ 0.13] = −$1,038,040.62 Difference_{A - B} = −$1,133,228.45 − (−$1,038,040.62)= −$95,187.83 Since the machine will not be replaced,Machine B should be purchased because it has the higher (less negative)NPV.

Question 18

Ripley Co.is considering a project that will produce sales of $36,700 and increase cash expenses by $14,600.If the project is implemented,the firm's taxes will increase from $17,420 to $21,680 and depreciation will increase from $4,000 to $5,500.What is the amount of the operating cash flow using the top-down approach?

Accepted Answer

OCF = $36,700 − $14,600 − ($21,680 − $17,420)= $17,840

Question 19

A project requires $1.08 million of new equipment that will be depreciated straight-line to zero over the project's 4-year life.The equipment is expected to be sold at the end of the project for 33 percent of its original cost.Net working capital equal to 12 percent of sales is required and will be recouped at the end of the project.Annual sales are projected at $487,500 with annual costs of $302,400.What is the recovery amount attributable to net working capital at the end of the project?

Accepted Answer

NWC recapture = 0.12 × $487,500 = $58,500

Question 20

The Java House is considering a project that will produce sales of $59,280 and increase cash expenses by $26,040.If the project is implemented,taxes will increase by $4,600.The additional depreciation expense will be $10,100.An initial cash outlay of $7,300 is required for net working capital.What is the amount of the operating cash flow using the top-down approach?

Accepted Answer

OCF = $59,280 − $26,040 − $4,600 = $28,640

Quiz 8: Making Capital Investment Decisions

The Market is considering a project that will require the purchase of $1.27 million in new equipment.The equipment will be depreciated straight-line to zero over the 6-year life of the project.What is the value of the depreciation tax shield in Year 2 of the project if the tax rate is 35 percent?

The initial cost of a machine is $727,000 with annual operating costs of $39,600.Each machine has a life of 5 years before it is replaced.Ignore taxes.What is the equivalent annual cost of this machine if the required return is 16 percent?

Kay's Quilts is considering a project that will reduce inventory by $38,000,increase accounts payable by $55,000,and increase accounts receivables by 9 percent.Accounts receivable is currently $78,000.What is the cash flow at Time 0 for net working capital?

Assume a machine costs $129,000 and lasts 3 years before it is replaced.The operating cost is $7,200 a year.Ignore taxes.What is the equivalent annual cost if the required rate of return is 14 percent?

Peter's Boats has sales of $711,000 and a profit margin of 7.8 percent.The annual depreciation expense is $59,000.The tax rate is 35 percent.What is the amount of the operating cash flow if the company has no long-term debt?