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Exam 9: Fundamentals of Capital Budgeting

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Question 1

Multiple Choice

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Which of the following statements is FALSE?

A) We begin the capital budgeting process by determining the incremental earnings of a project.
B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre-tax income.
C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings.
D) The opportunity cost of using a resource is the value it could have provided in its best alternative use.

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C

Question 2

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Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost to buy the machine and $12,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional The machine is expected to have a working life of six years. If straight-line depreciation is used, what are the yearly depreciation expenses in this case?

A) $666,667
B) $668,667
C) $1,166,667
D) $1,168,667

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Question 3

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If available, should MACRS be preferred to straight-line depreciation?

What is the major difference between scenario analysis and sensitivity analysis?

A company buys tracking software for its warehouse which, along with the computer system and ancillaries to run it, will cost $1.6 million. This purchase will be deducted over five years. It is expected that the software will reduce inventory by $10.7 million at the end of the first year after it is installed, though there will be an annual cost of $120,000 per year to run the system. If the company's marginal tax rate is 40%, how will the purchase of this item change the company's free cash flows in the first year?

An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called ________.

Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?

Which of the following statements is FALSE?

MACRS A machine is purchased for $575,000 and is used through the end of Year 2. The machine will be depreciated using the 3-Year MACRS schedule. At the end of Year 2, the machine is sold for $75,000. What is the after-tax cash flow from the sale of the machine at the end of Year 2 if the firm's marginal tax rate is 35%?

Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $21 million in revenues during its first and only year in operation (paid in one year) . Operating expenses are expected to total $8 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35% Assume that THSI's cost of capital for this project is 15%. The net present value (NPV) of this temporary housing project is closest to ________.

A firm is considering investing in a new machine that will cost $400,000 and will be depreciated straight-line over five years. If the firm's marginal tax rate is 39%, what is the annual depreciation tax shield of purchasing the machine?

The term "cannibalization" refers to ________.

Which of the following statements is FALSE?

Which of the following is an example of cannibalization?

CathFoods will release a new range of candies which contain anti-oxidants. New equipment to manufacture the candy will cost which will be depreciated by straight-line depreciation over six years. In addition, there will be spent on promoting the new candy line. It is expected that the range of candies will bring in revenues of per year for five years with production and support costs of $1.5 million per year. If CathFoods' marginal tax rate is 35%, what are the incremental earnings in the second year of this project?

Use the figure for the question(s) below. -A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. The assumptions regarding which parameter should be scrutinized most carefully in the estimation process?

Firms should use the most accelerated depreciation scheme allowable.

Panjandrum Industries, a manufacturer of industrial piping, is evaluating whether it should expand into the sale of plastic fittings for home garden sprinkler systems. It has made the above estimates of free cash flows resulting from such a decision (all quantities in millions of dollars) . There are some concerns that estimates of manufacturing expenses may be low, due to the rising cost of raw materials. What is the break-even point for manufacturing expenses, if all other estimates are correct and the cost of capital is 9%?

Vernon-Nelson Chemicals is planning to release a new brand of insecticide, Bee-Safe, that will kill many insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost and there will be an additional cost to reconfigure existing plant. The equipment is expected to have a lifetime of nine years and will be depreciated by the straight-line method over its lifetime. The firm expects that they should be able to sell 1,500,000 gallons per year at a price of $53 per gallon. It will take $36 per gallon to manufacture and support the product. If Vernon-Nelson's marginal tax rate is 40%, what are the incremental earnings after tax in year 3 of this project?

The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If Sisyphean's marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the company's new project?