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Exam 10: Making Capital Investment Decisions

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Question 1

Multiple Choice

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Hollister & Hollister is considering a new project.The project will require $543,000 for new fixed assets,$218,000 for additional inventory,and $42,000 for additional accounts receivable.Short-term debt is expected to increase by $165,000.The project has a 6-year life.The fixed assets will be depreciated straight-line to a zero book value over the life of the project.At the end of the project,the fixed assets can be sold for 20 percent of their original cost.The net working capital returns to its original level at the end of the project.The project is expected to generate annual sales of $875,000 with costs of $640,000.The tax rate is 34 percent and the required rate of return is 13 percent.What is the project's cash flow at time zero?

A) -$536,000
B) -$638,000
C) -$720,000
D) -$779,000
E) -$944,000

F) B) and C)
G) A) and E)

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B

Question 2

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Which one of the following is a project cash inflow? Ignore any tax effects.

A) decrease in accounts payable
B) increase in inventory
C) decrease in accounts receivable
D) depreciation expense based on MACRS
E) equipment acquisition

F) C) and E)
G) A) and E)

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Question 3

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Pro forma statements for a proposed project should: I.be compiled on a stand-alone basis. II.include all the incremental cash flows related to the project. III.generally exclude interest expense. IV.include all project-related fixed asset acquisitions and disposals.

Heer Enterprises needs someone to supply it with 225,000 cartons of machine screws per year to support its manufacturing needs over the next 7 years,and you've decided to bid on the contract.It will cost you $1,230,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life.You estimate that in 7 years,this equipment can be salvaged for $75,000.Your fixed production costs will be $360,000 per year,and your variable production costs should be $13.20 per carton.You also need an initial investment in net working capital of $112,500,all of which will be recovered when the project ends.Your tax rate is 32 percent and you require a 13 percent return on your investment.What bid price per carton should you submit?

Which one of the following best describes the concept of erosion?

Mason Farms purchased a building for $689,000 eight years ago.Six years ago,repairs were made to the building which cost $136,000.The annual taxes on the property are $11,000.The building has a current market value of $840,000 and a current book value of $494,000.The building is totally paid for and solely owned by the firm.If the company decides to use this building for a new project,what value,if any,should be included in the initial cash flow of the project for this building?

Which one of the following would make a project unacceptable?

Webster & Moore paid $148,000,in cash,for a piece of equipment 3 years ago.At the beginning of last year,the company spent $21,000 to update the equipment with the latest technology.The company no longer uses this equipment in its current operations and has received an offer of $96,000 from a firm that would like to purchase it.Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used.When evaluating the expansion option,what value,if any,should the firm assign to this equipment as an initial cost of the project?

Champion Bakers uses specialized ovens to bake its bread.One oven costs $689,000 and lasts about 4 years before it needs to be replaced.The annual operating cost per oven is $41,000.What is the equivalent annual cost of an oven if the required rate of return is 13 percent?

Phone Home,Inc.is considering a new 4-year expansion project that requires an initial fixed asset investment of $3 million.The fixed asset will be depreciated straight-line to zero over its 4-year tax life,after which time it will have a market value of $225,000.The project requires an initial investment in net working capital of $330,000,all of which will be recovered at the end of the project.The project is estimated to generate $2,640,000 in annual sales,with costs of $1,056,000.The tax rate is 33 percent and the required return for the project is 15 percent.What is the net present value for this project?

You own some equipment that you purchased 4 years ago at a cost of $225,000.The equipment is 5-year property for MACRS.You are considering selling the equipment today for $87,000.Which one of the following statements is correct if your tax rate is 35 percent? $\begin{array}{l}\text { MACRS 5-year property }\\\begin{array} { c c } \frac { \text { Year } } { 1 } & \frac { \text { Rate } } { 20.00 \% } \\2 & 32.00 \% \\3 & 19.20 \% \\4 & 11.52 \% \\5 & 11.52 \% \\6 & 5.76 \%\end{array}\end{array}$

The Pancake House has sales of $1,642,000,depreciation of $27,000,and net working capital of $218,000.The firm has a tax rate of 35 percent and a profit margin of 6 percent.The firm has no interest expense.What is the amount of the operating cash flow?

Which one of the following statements is correct?

The equivalent annual cost considers which of the following? I.required rate of return II.operating costs III.need for replacement IV.economic life

Peterborough Trucking just purchased some fixed assets that are classified as 3-year property for MACRS.The assets cost $10,600.What is the amount of the depreciation expense in year 3? $\text { MACRS 3-year property }$

Net working capital:

The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?

A project will produce an operating cash flow of $14,600 a year for 7 years.The initial fixed asset investment in the project will be $48,900.The net aftertax salvage value is estimated at $12,000 and will be received during the last year of the project's life.What is the net present value of the project if the required rate of return is 12 percent?

Bruno's Lunch Counter is expanding and expects operating cash flows of $29,000 a year for 4 years as a result.This expansion requires $39,000 in new fixed assets.These assets will be worthless at the end of the project.In addition,the project requires $3,000 of net working capital throughout the life of the project.What is the net present value of this expansion project at a required rate of return of 15 percent?

Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets.The firm is currently considering making handmade wreaths as well.Which one of the following is the best example of an incremental operating cash flow related to the wreath project?