[財管] HW4 Capital Budgeting Cash Flow Analysis

1. Which of the following statements is FALSE? (A) Sunk costs have been or will be paid regardless of the decision whether or not to proceed with the project. (B) Because value is lost when a resource is used by another project, we should include the opportunity cost as an incremental cost of the project. (C) Sunk costs are incremental with respect to the current decision regarding the project and should be included in its analysis. (D) When computing the incremental cash flow of an investment decision, we should include all changes between the firm's cash flow with the project versus without the project.

2. Which of the following statements is FALSE? (A) Earnings are not cash flows. (B) Any money that has already been spent is a sunk cost and therefore irrelevant in the capital budgeting process. (C)When evaluating a capital budgeting decision, we generally include interest expense. (D) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project.

3. The value of currently unused warehouse space that will be used as part of a new capital budgeting project is: (A) an opportunity cost. (B) irrelevant to the investment decision. (C) an overhead expense. (D) a sunk cost.

4. Which of the following cash flows are relevant incremental cash flows for a project that you are currently considering investing in? (A) The tax savings brought about by the project's depreciation expense (B) The cost of a marketing survey you conducted to determine demand for the proposed project (C) Interest payments on debt used to finance the project (D) Research and Development expenditures you have made

5. You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an investment of $40,000 in new equipment. This equipment will be depreciated straight line over five years. If your firm's marginal corporate tax rate is 35%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation? (A) $2800 (B) $14,000 (C) $5200 (D) $26,000

6. Inflation is treated properly in NPV analysis by: (A)discounting nominal cash flows by a nominal discount rate. (B)discounting real cash flows by a real discount rate. (C)discounting nominal cash flows by a real discount rate. (D)discounting real cash flows by a nominal discount rate. (E)both a and b.

7. Accounting earnings are not emphasized in capital budgeting decisions because they do: (A)not consider their timing or risk. (B)not measure all cashflows. (C)both of the above. (D)none of the above.

8. Net working capital should be considered in cashflows because: (A)firms must make sure the investment NPV calculation is positive. (B)firms must commit cash to short term assets to produce the finished goods. (C)taxes will erode the value otherwise. (D)these are sunk costs. (E) none of the above.

9. Which of the following is not a relevant item to consider in cash flow estimation? (A)a change in current assets invested in the project. (B)a change in current liabilities to finance new inventories. (C) regular meeting fees for the board of directors incurred when the go - no go decision is made. (D)any net changes in working capital over the life of the investment.

10. A project has a cost of $180. It will have a life of 3 years. The cost will be depreciated straight line to a zero salvage value, and is worth $40 at that time. Cash sales will be $200 per year and cash costs will run $110 per year. The firm will also need to invest $70 in net working capital at year 0. The appropriate discount rate is 8% (use for all flows), and the corporate tax rate is 40%. What are the cash flows in years 3? (A) 78 (B) 110 (C) 102 (D)200

11. The Equivalent Annual Annuity method allows comparison of the costs of equipment with unequal lives. If machine X has a five year life, and an NPV of $1,200, while machine Y has a four year life and an NPV of $1,100. Which machine would you choose if the business is expected to continue and the discount rate for both is 14%? (A) X, (B) Y, (C) both the same, (D) cannot decide.

12. An investigation of the degree to which NPV depends on assumptions made about critical variables is called a(n) (A)operating analysis (B)sensitivity analysis (C)marginal benefit analysis (D)decision tree analysis.

13. You are analyzing the following two mutually exclusive projects and have developed the following information. What is the crossover rate? (A) 9.38% (B) 11.11% (C) 13.01% (D) 14.90% (E) 16.75%

Year 0 1 2 3

Project A Cash Flow -$85,500 $29,000 $40,000 $27,000

Project B Cash Flow -$76,900 $25,000 $35,000 $26,000

14. The following two projects are mutually exclusive. The cost of capital is 9 percent. Based on IRR, which project should we choose? (A) Y, (B)Z, (C)the same, (D) can not be decided.

Project C0 C1 C2 C3 C4

Y -175 80 70 60 50

Z -350 125 125 125 125

15. The CFO’s decision to delay the project is an example of a(an) (A) timing option, (B) expansion option, (C) abandonment option, (D) switch option.

Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows for the first two years (in millions).

Year 1 2

Revenues 1200 1400

Operating Expense 450 525

Depreciation 240 280

Increase in working capital 60 70

Capital expenditures 300 350

Marginal corporate tax rate 30% 30%

16. The incremental EBIT for the Shepard Industries project in year one is closest to (A) $360 (B)$750 (C) $595 (D) $510

17. The incremental unlevered net income of the Shepard Industries project in year one is closest to: (A) $510 (B) $415 (C) $600 (D) $357

18.The depreciation tax shield for the Shepard Industries project in year one is closest to: (A) $84 (B) $168 (C) $96 (D) $72

19.The net free cash flow from the Shepard Industries project in year one is closest to: (A) $237 (B) $300 (C) -$5 (D) $390

20. If an investment project has an internal rate of return equal to the cost of capital, the NPV for that project: (A)is negative. (B)is positive. (C)is zero. (D)may be either positive or negative.

Sol:

1. C

2. C Not generally.

3. A

4. A

5. A

6. E https://accountingexplained.com/managerial/capital-budgeting/npv-and-inflation

7. C

8. B

9. C

10. C 90*0.6+60*0.4=78 for year 1,2 78+40*(0.6)=102 for year 3.

11. B X: EAA=349.54 Y: EAA=377.53

https://www.investopedia.com/terms/e/equivalent-annual-annuity-approach.asp

12. B

13. A -85500+76900+4000/(1.0938)+5000/(1.0938)^2+1000/(1.0938)^3=0.34

https://corporatefinanceinstitute.com/resources/knowledge/valuation/crossover-rate/

14. A IRR of Y=0.1971 IRR of Z=0.1597

15. A

https://ebrary.net/740/business_finance/real_options

16. D EBIT = Revenues – Op. Expenses – Depreciation = 510

17. D Incremental Unlevered Net Income = EBIT – Taxation = 357

18. D

19. A EBIT=1200-450-240=510 Net income=510-tax=510*(0.7)=357

Net free cash flow=357+Dep-60-300=237

20. C