Question 1

Operating cash flow (OCF)is calculated by adding back depreciation to the net operating profit after taxes.

Accepted Answer

When calculating operating cash flows, you subtract depreciation from EBITDA (Gross profit) and add it back to net operating profit after tax. The reason you first subtract depreciation and then add it back is to adjust taxable income so that the correct tax amount will be computed.

Question 2

Projects should be evaluated on the basis of accounting profits,as these profits actually cover the company's obligations.

Accepted Answer

Annual cash inflows aren't the same as accounting earnings. Annual cash inflows adjust the accounting earnings for depreciation.

Question 3

An outlay for installation costs is not considered part of the depreciable basis of the asset to be purchased.

Accepted Answer

Installation and shipping costs are considered part of the initial cost of acquiring the asset and are depreciated as if they were included in the initial cost of the item.

Question 4

Using the following data,what is the change in net working capital?

Accepted Answer

Change in NWC = Change in current assets - Change in current liabilities.
Change = (12,000 + 24,000) - (21,000 + 6,000) = 9,000

Question 5

The book value of an asset is equal to the

Accepted Answer

Book value = Initial cost - Accumulated depreciation.

Question 6

Bill Sharpe,owner of Sharper Knives Inc.,is closing his business at the end of the current fiscal year.His sole asset,the knife-sharpening machine,is four years old.A depreciation table for the asset is shown below.Bill has agreed to sell the machine at the end of the year for $100,000.What is the impact on taxes from the sale of the machine? (Assume that Sharper Knives claimed a regular depreciation expense in the calculation of income taxes.)The tax rate is 35%.Round your answers to the nearest dollar.
Depreciation Table for Knife Sharpener

Accepted Answer

Tax on sale = T × (S - B) We need the book value of the machine at the end of year 4: B₄ = $250,000 - $171,900 = $78,100 Tax on sale = 0.35 × ($100,000 - $78,100) = $7,665

Question 7

Jones Crusher Company is evaluating the proposed acquisition of a new machine.The machine will cost $190,000,and it will cost another $33,000 to modify it for special use by the firm.The machine falls into the MACRS 3-year class,and it will be sold after 3 years of use for $110,000.The machine will require an increase in net working capital of $9,000 and will have no effect on revenues,but is expected to save the firm $90,000 per year in before-tax operating costs,mainly labour.The company's marginal tax rate is 40%.What is the initial cash flow for the project?

Accepted Answer

Initial Cash Flow = -(Initial purchase price of new asset) - (Installation/shipping cost of new asset) - (Increase in net working capital)
Initial Cash Flow = -$190,000 - $33,000 - $9,000 = -$232,000

Question 8

Bill Sharpe,owner of Sharper Knives Inc.,is closing his business at the end of the current fiscal year.His sole asset,the knife-sharpening machine,is three years old.A depreciation table for the asset is shown below.Bill has agreed to sell the machine at the end of the year for $100,000.What is the impact on taxes from the sale of the machine? (Assume that Sharper Knives claimed a regular depreciation expense in the calculation of income taxes.)The tax rate is 35%.Round your answers to the nearest dollar.
Depreciation Table for Knife Sharpener

Accepted Answer

Tax on sale = T × (S - B)
We need the book value of the machine at the end of year 3: 11ea7fdb_fc77_17ac_a768_bdc4ff215aee_TB2902_11 = $250,000 - $140,675 = $109,325
Tax on sale = 0.35 × ($100,000 - $109,325) = -$3,264
A negative number implies a refund from the IRS.

Question 9

Droids-R-Us Inc.(DRU),is considering the installation of a new production line to make service mechanoids.The cost of the new manufacturing equipment is $2.2 million.The machines are classified as 7-year properties.(MACRS rates are provided in the table,below.)The machines will be purchased at the beginning of 2014.(DRU uses a mid-year placed-in-service convention.)DRU's engineers estimate that the new assembly line could be ready for operations in early 2014.Annual EBITDA is forecasted to be $1.3M for 2014 and all subsequent years of the project.DRU's marginal tax rate is 35%.What is the value of the depreciation tax shield in 2015? (Do NOT assume that the equipment is salvaged in 2015.)Round your answers to the nearest dollar.

Accepted Answer

First determine the amount of depreciation: Depr = d × C₀ 2015 is the second year of the asset's life so d = 0.2449 Depr = 0.2449 × $2,200,000 = $538,780. Compute the depreciation tax shield: Depreciation Tax Shield = T × Depr = 0.35 × $538,780 = $188,573

Question 10

A project having the conventional pattern of cash flows exhibits all of the following EXCEPT

Accepted Answer

A project following a conventional pattern of cash flows consists of an initial investment, operating cash inflows, and a terminal cash flow.

Question 11

The book value of an asset is equal to the asset's after-tax proceeds,provided after the asset has been sold.

Accepted Answer

The book value is the initial purchase price minus accumulated depreciation.

Question 12

The sale of an ordinary asset for its book value results in

Accepted Answer

The sale of an ordinary asset for its book value results in no tax benefit. A gain results in a tax on the sale, and a loss results in a tax benefit.

Question 13

The relevant cash flows for a proposed project are the incremental after-tax cash outflows and the resulting cash inflows.

Accepted Answer

The analysis of a project is substantially simplified by considering only incremental cash flows. An analysis of the incremental cash flows replaces an analysis of two scenarios: 1) the value of the firm without the project; and 2) the value of the firm with the project. Incremental cash flows are those that change as a result of accepting a project.

Question 14

Net working capital is the amount by which a firm's current assets exceed its current liabilities.

Accepted Answer

Net working capital is defined as current assets minus current liabilities.

Question 15

Projects will usually have an initial investment,cash inflows,and a terminal cash flow.

Accepted Answer

Cash flows for a project usually include an initial cash flow, annual cash flows, and a terminal cash flow.

Question 16

The initial purchase price of a new stamp press is $6,000.The firm will spend $5,000 on shipping and installation.Training of new employees will cost $2,000.As a result of the purchase,inventory must increase $1,300.What is the net initial cash flow? Round your answer to the nearest dollar.Sign your cash flows negative for outflows and positive for inflows.

Accepted Answer

Initial Cash Flow = - (Initial purchase price of new asset) - (Installation/shipping cost of new asset) - (Increase in net working capital)
Initial Cash Flow = -$6,000 - $5,000 - $2,000 - $1,300
Initial Cash Flow = -$14,300

Question 17

When the sale of an asset is equal to its book value,a firm will have to pay taxes on recaptured depreciation.

Accepted Answer

No taxable gain results when the sale of an asset is equal to its book value. The firm has not recaptured any depreciation in this transaction.

Question 18

When calculating the cash flows for a project,you should include interest payments.

Accepted Answer

The financing decision is separate from the capital budgeting decision. NPV and IRR include the cost of funds by using a discount rate that reflects the required return. If we were to include interest expense in the cash flow estimate, we would be, in essence, double charging the project for financing.

Question 19

A corporation has decided to replace an existing machine with a newer model.The old machine had an initial purchase price of $35,000,and has $20,000 in accumulated depreciation.If the 40% tax rate applies to the corporation and the old asset can be sold for $10,000,what will be the tax effect of the replacement?

Accepted Answer

Tax on Sale = T × (S - B)
Book Value = Initial Cost - Accumulated depreciation
Book Value = 35,000 - 20,000 = 15,000
Tax on Sale = 0.4 × (10,000 - 15,000)
Tax on Sale = -2,000
A negative tax is a refund.

Question 20

The initial outlays and operating costs of large projects can be forecast with great accuracy,but revenues are more uncertain and large errors are not uncommon.

Accepted Answer

Subsequent indirect costs of a large project are difficult to forecast accurately.

Quiz 10: Capital Budgeting - Cash Flows