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Exam 14: Cash Flow Estimation and Capital Budgeting Decisions

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Question 21

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Suppose a seven-year project requires an initial capital investment of $475,000 and an initial net working capital investment of $25,000.The project is expected to provide operating revenue of $350,000 per year.The associated operating costs are expected to be $150,000 per year.The capital asset belongs to Class 8 and has a CCA rate of 20 percent.The asset is expected to sell for $36,000 when the project ends.Assume the asset class remains open after the asset is sold.The firm's marginal tax rate is 40 percent and cost of capital is 8 percent.What impact would it have on the project's NPV if the operating costs increase by 5 percent?

A) NPV decreases by 8.22%
B) NPV decreases by 8.66%
C) NPV decreases by 8.96%
D) NPV decreases by 10.96%

E) A) and C)
F) A) and D)

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Question 22

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Use the following two statements to answer this question:

A) I and II are correct.
B) I and II are incorrect.
C) I is correct, II is incorrect.
D) I is incorrect, II is correct.
I.The initial after-tax cash flow refers to the total cash outlay that is required to initiate an investment project and can be depreciated for tax purposes.
II.The capital cost of an investment refers to all costs incurred to make an investment operational,which includes the additional working capital requirements.

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

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Question 23

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Why do cash flows need to be projected in nominal terms when market discount rates are used?

Given the following information on a project: initial capital cost = $500,000; installation costs associated with the capital asset = $25,000; R&D costs associated with the project = $50,000; associated opportunity costs = $80,000; increase in raw materials inventory = $10,000,which of these amounts is included with working capital?

Which of the following is NOT relevant to the cash flow estimates that are associated with a project?

Suppose a six-year project requires an initial capital investment of $425,000 and an initial net working capital investment of $50,000.The project is expected to provide operating revenue of $270,000 per year.The associated operating costs are expected to be $130,000 per year.The capital asset belongs to Class 9 and has a CCA rate of 30 percent.The asset is expected to sell for $40,000 when the project terminates.Assume the asset class remains open when the asset is sold.The firm's marginal tax rate is 40 percent and cost of capital is 8 percent.What impact would it have on the project's NPV if the cost of capital were 10 percent?

Bugs Buster is considering investing in a new risky project that requires $100,000 for the purchase of new equipment and $20,000 for additional net working capital.The equipment has a five-year life and a CCA rate of 30 percent.The equipment is expected to sell for $8,500 at the end of the project.Assume the asset class remains open after the asset is sold.The firm's cost of capital is 12 percent and marginal tax rate is 35 percent.The risk premium for the project is 3 percent.What is the present value of the terminal after-tax cash flow?

Why do we add the present value of the CCA tax shield to the NPV?

Use the following two statements to answer this question:

A software firm is considering developing a new financial planning software package.This new project is expected to sell 5,000 units per year and generate net operating cash flow of $100 per unit for the next five years.The relevant discount rate is 15 percent and the initial investment is $1.25 million.At what annual level of sales would it make sense to abandon the project if the project can be sold for $150,000 after the first year? Ignore taxes.

Which one of the following represents the change in net working capital?

In which of the following do we change one variable while holding the other variables constant to examine the impact on the NPV of a project?

Discuss the two ways inflation impacts capital budgeting.

A large printing company is considering purchasing a new printing press to replace the existing one that cost the company $1 million five years ago.The new machine will cost the company $1.8 million,has an economic life of ten years,and an expected salvage value of $150,000.The old machine can be sold for $200,000 today or could be sold for $10,000 in ten years.Both machines have a CCA rate of 30 percent and the asset class will remain open.The company projects that operating profit will increase by $400,000 per year.The company's tax rate is 40 percent and the cost of capital is 12 percent.What is the NPV of the replacement decision?

Which measure of inflation do you think should be used in capital budgeting: historical inflation or expected inflation.Explain why.

Which of the following should NOT be considered in the capital budgeting decision?

Maple Syrup Food is considering a six-year expansion project that requires an initial investment of $350,000 for the purchase of a new capital asset with a CCA rate of 20 percent.The costs to install the asset are $25,000.The projected annual sales revenue and costs are $200,000 and $90,000 per year,respectively.The appropriate discount rate is 10 percent.The firm's marginal tax rate is 40 percent.What is the fourth year CCA expense?

Which of the following is NOT a true statement?

Scenario analysis is a tool:

Abitibi Pulp Ltd.is considering a new product line for its existing table business.It has developed a new type of computer table that will protect the computer during an earthquake.It would like you to analyze the feasibility of the venture and suggests a break-even bid price.It provides you with the following details: $\bullet$ Marketing analysis indicates technology companies in Silicon Valley will buy 250 tables each year for four years. $\bullet$ The consultant who did the marketing research charged a fee of $15,000. $\bullet$ The firm estimates that the variable cost per table is $100.For this project the firm would require extra factory space at a cost of $25,000 per year,overhead costs such as heating and lighting would amount to $4,000 per year,and wages and salaries would total $75,000 per year. $\bullet$ The machinery required for the new product line would cost $200,000,and have a salvage value of $50,000 at the end of 4 years.The machinery belongs to CCA class 16 and has a 15 percent declining balance rate.The asset class will remain open. $\bullet$ Additional working capital of $150,000 would be required to get the project started. $\bullet$ The corporate tax rate is 40 percent and the required rate of return is 12 percent. What price should Abitibi charge for each table?