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Exam 11: Cash Flows and Capital Budgeting

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Question 41

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Your firm is evaluating the merits of several different machines. Machine A has a useful life of 5-years, generates an NPV of $53,250, an IRR of 13.6% and an equivalent annual cost of $10,316. Machine B has a useful life of 3-years, an NPV of $61,051, an IRR of 12.5%, and an equivalent annual cost of $9,724. Machine C has a useful life of 4-years, generates an NPV of $55,225, an IRR of 15.2% and an equivalent annual cost of $7,535 Machine D has a useful life of 7-years, generates an NPV of $64,020, an IRR of 11.4% and an equivalent annual cost of $8,885. Which machine should be purchased and why?

A) Machine C, because it has the highest IRR.
B) Machine D, because it has the highest NPV.
C) Machine A, because it has the most positive EAC
D) Machine B, because it has the shortest useful life.

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Question 42

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Which of the following should not be included in a project's cash flow calculations?

A) cash expenses
B) cash revenues
C) allocated expenses
D) None of the above.

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Question 43

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When compared to the straight-line depreciation method, MACRS has:

Evaluate the following statement: When analyzing a project, if the expected future cash flows are denominated in nominal dollars, then the discount rate should represent a nominal rate as well.

Evaluate the following statement: The MACRS depreciation tax schedule for three-year equipment provides a depreciation rate for a total of three years.

Expected cash flows: FireRock Wheel Corp is evaluating a project in which there is a 40 percent probability of revenues totaling $3 million and a 60 percent probability of revenues totaling $1 million per year. Its cash expenses will be $1.0 million while depreciation expense will be $200,000; then what is the expected free cash flow from taking the project if the marginal tax rate for the firm is 30 percent?

Ref 11-1 Provo, Inc., had revenues of $10 million, cash operating expenses of $5 million, and depreciation and amortization of $1 million during 2008. The firm purchased $500,000 of equipment during the year while increasing its inventory by $300,000 (with no corresponding increase in current liabilities) . The marginal tax rate for Provo is 40 percent. Reference: Ref 11-1 -Free cash flow: What is Provo's NOPAT for 2008?

Evaluate the following statement: You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not to begin harvesting the element. The correct choice is to begin harvesting immediately under all circumstances.

A firm is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. The project would also reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?

Free cash flow: What are Champagne's cash flows associated with investments for 2008?

Briefly explain the two methods of comparing projects with different useful lives.

Conceptually, free cash flows are what is left over for distribution to creditors and stockholders after the firm has made the necessary investments in working capital and long-term assets.

Allocated costs such as corporate overhead should be included in free cash flow calculations.

If you are discounting a project's cash flows using the nominal cost of capital, then that means that you have taken _______ into account:

The cash flows used in capital budgeting calculations are based on:

If Company Xhas the option of leasing some factory space to Company Y or utilizing it for another product line, then how should Company X handle the lost lease payments on the factory space if it chooses the product line?

Evaluate the following statement: Since our perspective when evaluating a project is that of all of the investors in the firm, creditors as well as stockholders, then we should use the pre-tax cash flows produced by the project. .

Average versus Marginal Tax Rate: Suppose Franklin Corporation had pre-tax income of $300,000 in 2010 and that the firm would have paid $100,250.00 in federal income taxes. What is Franklin's average income tax rate? (Round off to the nearest 0.1%)

The NPV of a project includes:

When to harvest an asset: Farmer Ag owns a special species of cotton-producing plant that, if left unharvested, grows a bigger bowl of cotton through time. The NPV, at the beginning of the year that harvesting takes place, is as follows. When should Farmer Ag harvest its cotton? Assume a discount rate of 14 percent. NPV₁ = $50,000 NPV₂ = $60,000 NPV₃ = $69,000 NPV₄ = $77,280 NPV₅ = $85,008