CHAPTER
9
1.
Which of the following can be depreciated for tax purposes?
I. Machinery and equipment
II. Land
III. Buildings
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II,
and III
2.
Conventional capital budgeting analysis will tend to understate the true
NPV of a project unless each of the following options EXCEPT ________ is
considered.
A) a contingency
plan option
B) the option to
default
C) the option to
expand
D) the option to
abandon
E) the
option to wait
3. A
financial manager reviewing a project is concerned about the level of
forecasting risk in the project's forecasted cash flows. The manager should use
_______ to identify the variable that presents the highest degree of forecasting
risk.
A)
scenario analysis
B)
simulation analysis
C)
sensitivity analysis
D)
break-even analysis
E)
strategic options analysis
4.
Which of the following statements is NOT accurate regarding pro forma
statements?
A) In order to
construct pro forma statements you generally forecast unit sales first
B) Pro forma
statements are generally prepared for more than one year ahead
C) Pro forma
statements merely represent the best current estimate of the future
D) Pro forma
statements need only be prepared when undertaking a capital budgeting decision
or applying for a bank loan
E) It is
important that pro forma statements be as accurate as possible
5.
Which of the following describe(s) project cash flow?
I. OCF - changes in NWC - capital spending
II. OCF + changes in NWC + capital spending
III. OCF + changes in NWC - capital spending
IV. OCF + reductions in NWC + capital spending
A) I only
B) I and III only
C) I and IV only
D) II and III only
E) I, II,
III, and IV
6. In
previous chapters, we computed NPV based on a project's forecasted cash flows.
When doing what-if analysis, this initial estimate is called the _______.
A) initial
analysis
B) first go-around
C) base case
D) initial
projection
E) best case
scenario
7.
Which of the following describe(s) relevant cash flows for the purpose of
performing capital budgeting analysis?
I. Cash flows must be incremental
II. Cash flows must be after-tax
III. EBIT + DEPN - Taxes
IV. Changes in net working capital
A) I and III only
B) I, II, and III
only
C) I and IV only
D) II, III, and IV
only
E) I, II,
III, and IV
8.
Suppose you purchase a machine for $12,000. The cost is depreciated
straight-line to a salvage value of $2,000 over its 4 year life. If the machine
is sold at the end of the third year for $6,000, what are the after-tax proceeds
from the sale assuming the tax rate is 34%?
A)
$1,010
B)
$3,510
C)
$5,010
D)
$5,490
E)
$6,990
9.
Given the following information and assuming straight-line depreciation
to zero, what is the profitability index for this project? Initial investment =
$500,000; life = 5 years; revenues = $160,000 per year; salvage = $20,000 in
year 5; tax rate = 34%; discount rate = 13%.
A) 0.45
B) 0.74
C) 0.99
D) 1.65
E) 1.98
Use
the following to answer question 10:
The
managers of PonchoParts, Inc. plan to manufacture engine blocks for classic cars
from the 1960s. They expect to sell 250 blocks annually for the next 5 years.
The necessary foundry and machining equipment will cost a total of $800,000 and
will be depreciated on a SL basis to zero over the project's life. The firm
expects to be able to sell the equipment for $150,000 at the end of 5 years.
Labor and materials costs total $500 per engine block, fixed costs are $125,000
per year. Assume a 35% tax rate and a 12% discount rate.
10.
What is the expected after-tax cash flow to the firm when the equipment
is sold in year five?
A)
$65,000
B)
$97,500
C)
$100,000
D)
$115,000
E)
$120,125
Use
the following to answer question 11:
Assume
straight-line depreciation to zero over the life of the project.
Year
Sales
1
10,000
2
12,500
3
15,625
4
19,531
5
24,414
6
30,518
Unit
Price: $50
years 1-3
$45 years 4-6
Changes
in NWC: $30,000
investment required initially
NWC balance will be maintained at 7.5% of sales each year
Variable
Cost: $35
per unit
Fixed
Cost: $50,000
per year
Initial
Investment:
$600,000
Salvage:
$50,000 at the end of year 6
tc:
34%
required
return: 12%
11.
What is the operating cash flow for year 5?
A)
$66,429
B)
$107,426
C)
$117,406
D)
$162,132
E)
$189,025
Use
the following to answer question 12:
Suppose
you are evaluating a project for The Ultimate recreational tennis rackets,
guaranteed to correct that wimpy backhand. You estimate the sales price of The
Ultimate to be $400 and sales to be 1,000 units in year 1, 1,250 units in year
2, and 1,325 units in year 3. In addition, you figure the project has a life of
3 years. Variable costs amount to $225 per unit and fixed costs are $100,000 per
year. The project requires an initial investment of $165,000 which is
depreciated straight-line to zero over the three year life of the project. The
actual market value of the initial investment after year 3 is $35,000. Initial
net working capital (NWC) investment is $75,000 and NWC will maintain a level
equal to 20% of sales each year thereafter. The tax rate is 34% and the required
return on the project is determined to be 10%.
12.
What is the total cash flow in year 3?
A)
$126,461
B)
$178,156
C)
$194,945
D)
$228,838
E)
$229,100
13. In _______________
we investigate the impact on NPV of allowing one variable to change while
holding all other variables constant.
A)
scenario analysis
B)
break-even analysis
C)
strategic options analysis
D)
simulation analysis
E)
sensitivity analysis
Use
the following to answer question 14:
BASIC
INFOMATION: A three-year project will cost $60,000 to construct. This will be
depreciated straight-line to zero over the three-year life. The price per unit
sold is $20 and the variable costs per unit sold is $10. Fixed costs are $30,000
per year.
14. In addition to the
BASIC INFORMATION, you find that a salvage company will pay you $10,000 for the
assets at the end of year three. The project will require an investment of
$10,000 up front for net working capital. If you expect to sell 7,000 units per
year, compute the NPV assuming a required return of 15% and a tax rate of 30%.
A) Less than $0.00
B)
$11,347
C)
$14,416
D)
$18,807
E)
More than $20,000
Use
the following to answer questions 15-16:
You
are considering a project that requires an initial investment of $10,000. It is
depreciable over four years using straight-line depreciation. The discount rate
is 10%. Your tax bracket is 34% and you receive a tax credit for negative
earnings in the year in which the loss occurs.
Base
Lower
Upper
Case
Bound
Bound
Unit
Sales 3,000 2,750
3,250
Price/unit
$14
$13 $16
Variable
cost/unit $9 $8
$10
Fixed
costs $9,000 $8,500
$10,000
15.
What is the best case NPV for the project?
A)
$5,247
B)
$26,462
C)
$29,306
D)
$32,327
E)
$34,252
16.
What is the worst case NPV for the project?
A)
-$11,594
B)
-$10,967
C)
-$4,423
D)
-$2,327
E)
$3,677
17. A firm that faces
capital rationing must select a subset of capital projects based on some ranking
criterion. The capital budgeting technique best suited for this is the _______.
A) NPV
B) IRR
C) PI
D) AAR
E)
payback
18. It is important to
identify and use only incremental cash flows in capital investment decisions
A)
because they are the simplest to identify
B) only when the
stand alone principle fails to hold
C)
because ultimately it is the change in a firm's overall future cash flows
that matter
D) in order to
accommodate unforeseen changes that might occur
E)
whenever sunk costs are involved
19.
Which of the following is NOT considered an incremental cash flow in
capital budgeting analysis?
A)
Opportunity cost
B)
Erosion
C)
Changes in NWC
D) Sunk cost
E)
Fixed asset salvage values at end of project.
20.
Which of the following is/are generally LEAST subject to forecasting
risk?
I. Projected sales
II. Initial investment
III. Projected fixed costs
A) I only
B) II only
C) III only
D) I and II only
E) I and III
only
Answer
Key
1. C
2. B
3. C
4. D
5. A
6. C
7. E
8. D
9. C
10. B
11. D
12. D
13. E
14. D
15. C
16. B
17. C
18. C
19. D