BUS 350 Principles of finace Chapter 12 smartbook

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Excelsior University *

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Jan 9, 2024

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Which one of these is not one of the four basic financial statements? Statement of ratios What does a balance sheet do? reports a firm's assets, liabilities, and equity at a particular point in time What is the balance sheet identity formula? Assets = Liabilities + Equity Rank these assets in order of liquidity with the most liquid asset listed first. 1. Cash 2. Accounts Receivable 3. Inventory 4. Plant and equipment Which of these examples best defines a liquid asset? Mia sold 100 shares of stock today at the going market price. A financial statement provides an Blank______-based picture of a firm's financial condition. accounting Which of these assets have useful lives exceeding one year and are classified as fixed assets? Machinery

Land Building Which one of these statements correctly applies to a balance sheet? A balance sheet shows what a firm owns, what it owes, and what it is worth. Which one of these correctly defines the balance sheet identity? Equity = Assets - Liabilities A current asset is an asset that does which one of the following? A current asset provides liquidity and a low rate of return. A firm has fixed assets of $28,000, long-term debt of $12,000, current liabilities of $4,000, current assets of $5,000 and equity of $17,000. What is the total of the assets side of the balance sheet of the firm? $33,000 Total assets = Current assets + Fixed assets = $5,000 = $28,000 = $33,000 What is the definition of liquidity? Liquidity is the ease of conversion of an asset into cash at a fair value. Which of these assets are generally converted into cash within one year? Accounts receivable Inventory

What is the definition of a current asset? A current asset is an asset that can be converted into cash within one year. Which one of these is a current asset? cash account receivable What is the definition of a marketable security? A marketable security is a short-term, low-rate investment security. A fixed asset is an asset that is defined as having a useful life in excess of which one of these time periods? One year Which one of these is an intangible long-term asset? Trademark How is net plant and equipment calculated? Net plant and equipment is equal to gross plant and equipment less accumulated depreciation Which of these characteristics apply to a marketable security?

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Provides a low rate of return Convertible to cash within one year or less Which one of these reports the amount of money a firm owes its creditors within the next year? Current liabilities How is the fixed nature of an asset determined? A fixed nature of an asset is determined by its useful life. What is the definition of liabilities? Liabilities are funds provided by lenders to a firm. Which of these are fixed assets? land owned by a retail outlet, sewing machines owned by a clothing manufacturer Buster's owns a machine which cost $110,000 initially. The latest financial statement shows depreciation expense of $22,000 and accumulated depreciation of $77,000. What is the book value of the firm's net plant and equipment? $33,000 Reason: $110,000 - $77,000 = $33,000

What is the definition of current liabilities? Current liabilities are obligations of the firm that are due within one year. Which of these are equity accounts? Preferred stock Retained earnings Common stock Which one of these actions meets the definition of a liability? Corner Bank loans $100,000 to the Corner Bakery for two years. Which one of these is a current liability? 6-month note payable What is the definition of long-term debt? Long-term debt is defined as the obligations of the firm that are due in more than one year. Which one of these accounts is a long-term debt? 5-year bonds Current liabilities are debts of a firm that must be paid within what time frame? One year

Which of these questions can be answered by monitoring a firm's balance sheets for last year and this year? Is the firm more or less liquid than last year? Did the firm issue additional shares of stock this year? Which of these definitions of stockholders' equity is correct? Stockholders' equity is defined as the funds provided by the firm's preferred and common stock owners. Which of these accounts are current liabilities? Accounts payable Notes payable Accrued wages Long-term debt is defined as the obligations of the firm that are due after what period of time? One year Which of these accounts are long-term debts? 15-year mortgage 10-year bonds What is the definition of preferred stock? Preferred stock is a hybrid security that has characteristics of both long-term debt and common stock.

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Which one of these questions can be answered by monitoring a firm's balance sheets? Level of net working capital Stockholders' equity can be defined by which one of these formulas? Stockholders' equity = Assets - Liabilities True or false: Both common stock and paid in surplus represent a fundamental ownership claim in either a private or a public company. True Which one of these formulas correctly defines retained earnings? Total net earnings for all years - Total dividends paid for all years Which of these characteristics apply to the definition of preferred stock? Fixed periodic payments Ownership interest in the firm Which type of depreciation offers the greatest tax deferral benefit in the early years of an asset's life? MACRS depreciation Which of these accounts are included in net working capital? Notes payable

Inventory Cash Accounts payable Accounts receivable What is the definition of common stock and paid in surplus? Common stock and paid in surplus represent the fundamental ownership claim in a public or private company. What is the definition of retained earnings? Retained earnings is the cumulative earnings a firm has reinvested rather than paid out as dividends. Which account is the least liquid of the current asset accounts? Inventory Which one of these statements correctly applies to straight-line depreciation? Straight-line depreciation is commonly used when compiling financial statements. True or false: Net working capital is a measure of a firm's ability to pay its bills within a year. True Balance sheets list assets in declining order of liquidity. Which of these orders best illustrates this? Cash, accounts receivable, inventory, plant and equipment

Which one of these relationships regarding liquidity is correct? As the liquidity of assets increases, both the firm's probability of financial distress and its profits on those assets decrease. What is the definition of net working capital? Net working capital is the difference between a firm's current assets and current liabilities. Which one of the following best illustrates a highly liquid asset? Sale of a $100 asset by tomorrow at a price of $100. How can financial leverage be defined? Financial leverage is the degree to which a firm finances its total assets with debt securities. True or false: An increase in the financial leverage of a firm reduces both the firm's profits and its losses. False How is the capital structure of a firm defined? Capital structure is the amount of debt versus equity financing held on the balance sheet. Which relationship of liquidity is correct? The liquidity of an asset is inversely related to the profitability of that asset.

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How is the book value of land defined? The book value of land is its historical cost, or the amount paid for that land. Which one of these assets is considered to be the most liquid? Accounts receivable How is financial leverage defined? Financial leverage is the extent to which debt securities are used by a firm. Which sentence best illustrates the definition of market value? If the Cookie Palace sells its oven today, it could receive a price of $89,000. A change in financial leverage does which one of the following? A decrease in financial leverage decreases the risks faced by the firm. Which one of these comparisons fits the definition of capital structure? The capital structure of a firm compares the total debt to the total equity. Which statement correctly defines the book value of a firm's assets as shown in the gross plant and equipment account?

The book value of a firm's assets in the gross plant and equipment account is the total amount the firm paid for those assets. Which one of these is the best explanation of the market value per share (MVPS)? MVPS is the current price at which a share of common stock sells in the open market. D.O. Co. has a total of $6,500 in total assets and $4,200 in fixed assets on its balance sheet. The fixed assets were just appraised at $4,700. The firm feels it can liquidate its current assets for 96 percent of their book value. What is the book and market value of the firm's assets? The book value is $6,500 and the market value is $6,908. How is the market value of an asset defined? The market value of an asset is the amount the firm would receive if it sold the asset. Book value per share (BVPS) is based on which one of the following? BVPS is based on the equity of a firm that is attributable to the common shareholders. What is the definition of an income statement? An income statement reports total revenues and expenses over a specific period of time. Which one of these terms is the price at which one share of common stock can currently be sold? Market value per share

Jed's balance sheet lists cash of $300, accounts receivable of $700, inventory of $1,200, and fixed assets of $2,800. The inventory can be sold for 95 percent of its costs while 98 percent of the receivables can be collected. The fixed assets can be sold for $2,700. What are the book and market values of the firm's assets? The book value is $5,000 and the market value is $4,826. Reason: Book value = $300 + $700 + $1,200 + $2,800 = $5,000 Market value = $300 + (0.98 × $700) + (0.95 × $1,200) + $2,700 = $4,826 When computing book value per share (BVPS) which of these balance sheet values is used as the total book value? Common stock + Paid in surplus + Retained earnings Which of the following calculations are made on the income statement? Net sales minus the cost of goods sold equals gross profit. Income from operations minus interest expense equals income before taxes. Income before income taxes minus income taxes equals net income. Gross profit minus selling, general, and administrative expenses equals income from operations. An income statement is best defined by which one of these statements? An income statement reflects the total revenues that a firm earns over a period of time and the total expenses incurred to generate those sales. A firm has sales of $8,900, depreciation of $200, cost of goods sold of $3,700, other operating expenses of $4,200, and interest of $600. What is the firm's EBIT? $800 Reason:

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EBIT = Sales - Cost of goods sold - Depreciation - Other operating expenses = $8,900 - $3,700 - $200 - $4,200 = $800 A firm has net income of $2,200, depreciation of $500, taxes of $600, other operating expenses of $800, interest of $200, and sales of $5,900. What is the value of EBT? $2,800 Reason: EBT = Net income + Taxes = $2,200 + $600 = $2,800 A firm has sales of $2,800, depreciation of $200, earnings before interest and taxes (EBIT) of $900, and other operating expenses of $400. What is the gross profit? $1,500 Reason: Gross profit = EBIT + Other operating expenses + Depreciation = $900 + $400 + $200 = $1,500 Rearrange the following accounts or captions in the order in which they appear on the income statement: 1. Income from operations 2. Income taxes 3. Cost of goods sold 4. Gross profit 3, 4, 1, 2 Which one of these formulas is a correct computation of EBIT? EBIT = Gross profits - Depreciation - Other operating expenses A firm has EBIT of $700, depreciation of $100, taxes of $200, and interest of $300. What is the net income? $200

Reason: Net income = EBIT - Interest - Taxes = $700 - $300 - $200 = $200 Which one of these formulas correctly computes the value of EBT? EBT = Net income + Taxes How is gross profit defined? Gross Profit = Net Sales - Cost of Goods Sold Les' Market has net sales of $1,300, depreciation of $100, cost of goods sold of $600, and other operating expenses of $200. What is the gross profit amount? $700 Reason: Gross profit = Sales - Cost of goods sold = $1,300 - $600 = $700 What is the definition of EBIT? EBIT is the earnings before interest and taxes. How can EBT be defined? EBT is earnings before taxes, also referred to as taxable income. A firm has gross profits of $3,200, depreciation of $300, dividends of $200, interest of $500, and addition to retained earnings of $400, What is the net income?

$600 Reason: Net income = Dividends paid + Addition to retained earnings = $200 + $400 = $600 A firm has total assets of $439,000, current assets of $49,000, total equity of $283,000 and long-term debt of $107,000. How do you compute net working capital (NWC)? NWC = $49,000 - ($439,000 - $107,000 - $283,000) Gross profit is equal to net sales minus cost of goods sold. How else can gross profit be defined? Gross profit = EBIT + Other operating expenses + Depreciation Which one of these defines net income? Net income is the amount of profit a firm can either distribute as dividends or reinvest in the firm Which one of these correctly defines EBIT? EBIT is the earnings a firm generates prior to paying interest to its creditors or income taxes to the government. Which one of these statements is a correct interpretation of an income statement? Earnings per share = Net income available to common stockholders / Total shares of common stock outstanding What is the definition of EBT? EBT is the taxable income of a firm.

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Dalton Bros. has 5,000 shares of common stock outstanding, earnings before taxes of $3,000, preferred dividends of $1,000, common dividends of $500, and taxes of $900. What is the earnings per share (EPS) amount? $0.22 Reason: EPS = Income available to common stockholders/Total shares outstanding = ($3,000 - $900 - $1,000)/5,000 = $0.22 ___ holders have first claim to the cash flows of the firm. Debt A firm has total assets of $358,000 and fixed assets of $220,000. Current liabilities are $77,000 and long- term debt is $289,000. How do you compute net working capital (NWC)? NWC = ($358,000 - $220,000) - $77,000 What is the definition of net income? Net income is the aftertax profit or loss earned over a specified period of time. What is the definition of an average tax rate? The average tax rate is the percentage of each dollar of taxable income that the firm pays in taxes. Another name for the bottom line of an income statement is net income

Which one of these formulas will correctly compute the earnings per share (EPS)? EPS = Net income available to common stockholders/Total shares of common stock outstanding Which party has a residual claim to a firm's cash flows? Stockholders Which of one of these statements best illustrates the definition of a marginal tax rate? Antonio will pay $0.28 more in taxes if his taxable income increases by $1, or 28 percent. Which one of these formulas best defines an average tax rate? Average tax rate = Tax liability/Taxable income John owed $10,000 in taxes on taxable income of $40,000. If John earns an additional $1,000, he will pay an additional $280. Therefore: his average tax rate is about 25% True or false: All interest payments and dividends are deducted from operating income when the firm calculates taxable income. False What is the definition of a marginal tax rate?

The marginal tax rate is the amount of additional taxes a firm must pay out for every additional dollar of taxable income it earns. If Mary owes the IRS $5,000 for her income taxes and is in the 15% marginal tax bracket, what would be her average tax rate if she had taxable income of $41,667? About 12% Which of these reduce the taxable income of a corporation? Interest expense The Keyser Corporation owns 1,000 shares of Mountain Top Industries. How are the dividends paid by Mountain Top to Keyser treated for federal tax purposes? Thirty percent of the dividend income received is taxable, the other seventy percent is tax-exempt. What is the basic reason why debt financing affects the income available to asset funders? Interest is a tax-deductible expense. Delta's has operating income of $128,000 and a 35 percent tax rate and is all-equity financed. Sigma's has operating income of $128,000, a 35 percent tax rate, and has $15,000 in interest expense since it is partially debt-financed. What is the difference in the income available for asset funders between these two firms? $5,250 Reason: Asset funders includes both bondholders and stockholders so the difference = Tax savings on interest = 0.35($15,000) = $5,250

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Which of these statements regarding the federal taxation of interest income earned by a corporation is(are) correct? Interest earned on a bond issued by a city is tax-exempt. Interest earned on a corporate bond is taxable. Which one of these best explains how debt financing affects the income available to a firm's asset funders? Debt increases the income available to asset funders by an amount equal to the interest on the debt times the tax rate. Dexter's has operating income of $82,000 and a 30 percent tax rate and is all-equity financed. Brown's has operating income of $82,000, a 30 percent tax rate, and has $5,000 in interest expense since it is partially debt-financed. What is the difference in the income available for asset funders between these two firms? 1,500 Reason: Asset funders includes both bondholders and stockholders so the difference = Tax savings on interest = 0.30($5,000) = $1,500. The statement of cash ___ is a financial statement that provides a reconciliation of the opening and ___ total of cash and ___ ___. Blank 1: flows Blank 2: closing Blank 3: cash Blank 4: equivalent

Which one of these statements related to the recording of financial statement items based on GAAP is (are) correct? Expenses related to the production of a product are recorded on the income statement when that product is sold, not when the expenses are paid. Which one of these accounts is a noncash expense? amortization Depreciation A statement of cash flows reflects a net cash flow from operating activities of -$89 million, a net cash flow from investing activities of $42 million, and a net cash flow from financing activities of $28 million. What can you determine from this information? The firm sold long-term assets, issued securities, and reduced its cash holdings in order to finance its operations. A financial statement that provides a reconciliation of the opening and closing total of cash and cash equivalent balances is referred to as: the statement of cash flows Explain why following GAAP to record sales on an income statement may differ from the cash flows generated by those sales. GAAP requires the revenue from a sale be recorded at the time of sale, which may not coincide with the cash flow from the sale. Which of these statements regarding the federal taxation of interest income earned by a corporation is(are) correct? Select all that apply. Interest earned on a corporate bond is taxable.

Interest earned on a bond issued by a city is tax-exempt. Which of these is (are) a source of cash? Decrease in inventory Increase in long-term debt The statement of cash flows separates cash flows into which of the following categories? Cash flow from financing activities. Cash flow from investing activities. Net change in cash and marketable securities Cash flow from operating activities. Which of these statements is correct concerning the structure of a statement of cash flows? An increase in accounts payable is an addition to the cash flows from operating activities. A decrease in fixed assets is an addition to the cash flows from investing activities. Which one of the following is a use of cash? Increase in a fixed asset Which one of these is a subtraction from the cash flows from operating activities? Decrease in accrued wages and taxes True or false: A decrease in a long-term asset account balance is a cash flow from investing activity.

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True Interest payments on long-term debt are found in what section of the Statement of Cash Flows? Cash flows from operating activities Which one of these is an addition to the cash flows from investing activities? Decrease in other long-term assets Which one of these is an addition to the cash flows from operating activities? Decrease in accounts receivable Which one of these is a cash flow from an investing activity? Increase/decrease in fixed assets Which of these statements is correct concerning the structure of a statement of cash flows? A decrease in fixed assets is an addition to the cash flows from investing activities. An increase in accounts payable is an addition to the cash flows from operating activities. Which one of these is a cash flow from a financing activity? Decrease in loans payable Which one of these is a subtraction from the cash flows from investing activities?

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Increase in a fixed asset Which of these are additions to the cash flows from financing activities? Increase in long-term debt Increase in common stock Which of the following is not a cash flow from operating activities? payments of dividends to stockholders Which of these are cash flows from financing activities? Decrease in long-term debt Increase in common stock Preferred stock dividend True or false: The cash flows directly resulting from a firm's sales and production activities are classified as cash flows from investing activities. False Reason: The cash flows directly resulting from a firm's sales and production activities are classified as cash flows from operations. Which one of these is a subtraction from the cash flows from financing activities? Buying back common stock

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Which section of the statement of cash flows is most directly related to net income? cash flows from operating activities Which one of these is classified as a cash flow from operating activities? Decrease in accounts payable What is the definition of cash flows from operations? Cash flow from operations is defined as the cash flows that are the direct result of the production and sale of the firm's products. True or false: Cash flows that result from debt and equity financing transactions are cash flows from financing activities. True The section of the statement of cash flows that is most directly related to net income from the income statement is cash flows from ___ activities. Blank 1: operating True or false: The cash flows that result from debt and equity financing transactions are cash flows from financing activities. True

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Which of these are added or subtracted from net income to compute the net cash flows from operating activities? Decrease in accrued wages and taxes Depreciation Increase in inventory A statement of cash flows for the year ending December 31, 2012 shows a net change in cash and marketable securities of $20. How can this $20 change be defined? Cash and marketable securities were $20 more on December 31, 2012 than they were on December 31, 2011. Which one of these is the definition of cash flows from investing activities? Cash flow from investing activities is defined as the cash flows associated with the purchase or sale of fixed or other long-term assets. Kettles, Inc., paid $50,000 in preferred dividends and $100,000 in common dividends this year. There are 25,000 shares of preferred stock and 40,000 shares of common stock outstanding. What is the amount of the dividends per share (DPS)? 2.50 Reason: Dividends per share = Common stock dividends/Number of shares of common stock outstanding = $100,000/40,000 = $2.50 Cash flows from financing activities are defined as the cash flows resulting from which one of the following? Debt and equity financing transactions

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A firm has EBIT of $600, depreciation of $200, and a tax rate of 34 percent. What is the operating cash flow? 596 Reason: OCF = EBIT(1 - Tax rate) + Depreciation = $600(1 - 0.34) + $200 = $596 A firm has a negative free cash flow and a negative operating cash flow. What does this indicate? The firm is experiencing operating or managerial problems. Which one of these correctly defines the net change in cash and marketable securities as it is used on the statement of cash flows? The net change in cash and marketable securities is the sum of the cash flows from operations, investing activities, and financing activities. The statement of retained earnings reconciles the dividends paid and the change in retained earnings to which one of these? Net income Which one of these formulas will correctly compute dividends per share (DPS)? DPS = Common stock dividends paid/Number of shares of common stock outstanding A firm has an operating cash flow of $600, a net change in gross fixed assets of $100, and a change in net operating working capital of $50. What is the firm's free cash flow (FCF)? $450 Reason:

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IOC = Change in gross fixed assets + Change in net operating working capital. FCF = OCF - IOC = $600 - ($100 + $50) = $450. A firm with positive operating cash flow but negative free cash flow may be investing heavily in operating capital Assume net income is $32, cash dividends paid are $20, and the ending retained earnings balance is $44. What is the change in retained earnings for the period? 12 Reason: Change in retained earnings = Net income - Cash dividends paid = $32 - $20 = $12 Which one of these formulas depicts the definition of the statement of retained earnings? Net income = Dividends paid + Change in retained earnings A statement of retained earnings showed a beginning retained earnings balance of $24 and an ending balance of $22. Net income was positive. What do you know given this information? Cash dividends paid exceeded net income. Which of these actions fits the definition of earnings management? A major sale to a customer was purposely delayed one day so it would be recorded in a later accounting period. The Sarbanes-Oxley Act of 2002 requires senior management of a firm to do which one of these?

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Certify the financial statements are accurate and representative of the firm's earnings What is the definition of a statement of cash flows? A statement of cash flows is a financial statement that shows the firm's cash flows over a period of time. Earnings management is the process of controlling which of these for a firm? Profits Which of these is a requirement of the Sarbanes-Oxley Act of 2002? A corporate board's audit committee must have considerable experience with GAAP. Which one of these is the best definition of a statement of cash flows? A statement of cash flows summarizes the sources and uses of cash by type of cash flow. True or false: Net working capital is a measure of a firm's ability to pay its bills within a year. True What is pro forma analysis? Estimation of future project cash flows using only the relevant parts of the financial statements What is an incremental cash flow? A cash flow that either increases or decreases when a new project is implemented

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Which one of these represents an opportunity cost? Assigning a current employee to a new project Should opportunity costs be included in or excluded from project analysis? Why? Included; The firm must forego using the resource in any other way, thereby incurring a cost. What is the definition of net working capital? Net working capital is the difference between a firm's current assets and current liabilities. What is a sunk cost? A previously incurred cost that cannot be recovered In pro forma analysis, what determines whether or not an account on the balance sheet or income statement is relevant to a project? If the project causes an account value to change, then it is relevant. How can you determine if a cash flow is incremental to a project? Select all that apply. The cash flow will disappear when the project ceases. The cash flow occurs only if a new project is implemented. The cash flow changes only when a new project is implemented. Which of these represent opportunity costs? Select all that apply.

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Using a piece of company equipment that has been sitting idle for two years in a new project. Building a new building on a vacant lot owned by the firm. Using a current employee who is about to be laid off to run a project on a day by day basis. Opportunity costs are costs incurred when resources owned or employed by a firm have which one these characteristics? Multiple uses How can a sunk cost be recovered? Sunk costs cannot be recovered. What is pro forma analysis? Estimation of future project cash flows using only the relevant parts of the financial statements Why are sunk costs excluded from project analysis? The costs have been incurred and cannot be recouped with or without the project. What is an incremental cash flow? A cash flow that either increases or decreases when a new project is implemented Leo's currently sells $5,000 of wood toys and $2,000 of metal toys. Leo's wants to begin selling plastic toys. If it does, the expected sales are $7,500 of wood toys, $2,500 of metal toys, and $3,500 of plastic toys. What is the value of the complementary effect of the plastic toys? $3,000.

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Reason: Complementary effect = ($7,500 - $5,000) + ($2,500 - $2,000) = $3,000 Which one of these represents an opportunity cost? Assigning a current employee to a new project Which of these is the best description of the substitution effect? Any decrease in the level of sales, costs, or necessary assets of a firm's current operations that is caused by the implementation of a new project. Reason: This answer defines a complementary effect. Substitute effects are decreases in current sales or costs caused by a new project. Should opportunity costs be included in or excluded from project analysis? Why? Included; The firm must forego using the resource in any other way, thereby incurring a cost. What is a sunk cost? A previously incurred cost that cannot be recovered. Which of these illustrates a complementary effect? Select all that apply. A new product increases the sales of one of the firm's existing products. A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products. Mike's Garage spent $1,000 last week to repair its parking lot. No matter what Mike does, he cannot recoup this expense for his business. What type of cost is this?

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Sunk cost What is a financing cost? Interest and dividends paid as a result of external financing Krista's Place sells $15,000 of art work and $12,000 of craft supplies. If Krista's add home accessories, the projected sales become $12,000 of art work, $9,000 of craft supplies, and $13,000 of home accessories. What is the substitution effect of the home accessories? -$6,000. Reason: Substitution effect = ($12,000 -$15,000) + ($9,000 - $12,000) = -$6,000 How is a complementary effect defined? Any increase in the current level of sales, costs, or necessary assets of a firm's existing operations caused by a new project What is an opportunity cost? The value of the next best alternative use of a resource owned or employed by a firm Which one of these is an example of the substitution effect? Current employee costs are lowered due to the automation processes implemented by a new project Which of these are financing costs? Select all that apply. Bond interest Stock dividend

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Leo's currently sells $5,000 of wood toys and $2,000 of metal toys. Leo's wants to begin selling plastic toys. If it does, the expected sales are $7,500 of wood toys, $2,500 of metal toys, and $3,500 of plastic toys. What is the value of the complementary effect of the plastic toys? $3,000. Reason: Complementary effect = ($7,500 - $5,000) + ($2,500 - $2,000) = $3,000 Which of these is the best description of the substitution effect? Any decrease in the level of sales, costs, or necessary assets of a firm's current operations that is caused by the implementation of a new project Opportunity costs are costs incurred when resources owned or employed by a firm have which one these characteristics? Multiple uses How is bond interest included in the analysis of a new project? Bond interest is included in the computation of a bond's yield to maturity, which is the pretax cost of debt used to compute a project's WACC Which of these illustrates a complementary effect? Select all that apply. A new product increases the sales of one of the firm's existing products. A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products. Why are financing costs excluded from project cash flows?

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Financing costs are included in the required return used to discount project cash flows. What is a financing cost? Interest and dividends paid as a result of external financing What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. Krista's Place sells $15,000 of art work and $12,000 of craft supplies. If Krista's add home accessories, the projected sales become $12,000 of art work, $9,000 of craft supplies, and $13,000 of home accessories. What is the substitution effect of the home accessories? -$6,000. Reason: Substitution effect = ($12,000 -$15,000) + ($9,000 - $12,000) = -$6,000 What types of costs are included in an asset's depreciable basis? Select all that apply. Installation and testing costs Sales tax and freight charges Purchase price of the asset How is a complementary effect defined? Any increase in the current level of sales, costs, or necessary assets of a firm's existing operations caused by a new project

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Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention. (Depreciable basis - Ending book value)/Life of asset How are the dividends paid on stock included in the analysis of a new project? Financing costs, such as dividends, are considered in the component costs of capital when a project's WACC is calculated. True or false: Since financing costs are included in project WACC, which are used to discount project cash flows, we need to count them as expenses on the project False Free cash flows for which one of the following are affected by estimation error? Project free cash flows only McGinty's purchased a new machine for $318,000, paid $19,000 in sales tax, and $7,500 in delivery charges. The firm paid $3,400 to have the machine calibrated once it was set in place. The machine requires $5,600 of annual maintenance. What is the depreciable basis of the machine? Multiple choice question. $340,400 $347,900. Reason: Depreciable basis = $318,000 + $19,000 + $7,500 + $3,400 = $347,900 A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed?

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($28,000 - $5,000)/5 How can straight-line depreciation be defined? Ignore the half-year convention. Total amount to be depreciated spread evenly over an asset's life How is bond interest included in the analysis of a new project? Bond interest is included in the computation of a bond's yield to maturity, which is the pretax cost of debt used to compute a project's WACC Why are financing costs excluded from project cash flows? Financing costs are included in the required return used to discount project cash flows. What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention. ($28,000 + $2,000 - $5,000)/6 Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention. (Depreciable basis - Ending book value)/Life of asset

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The Foster House purchased a machine costing $10,000 and paid $600 in sales tax. Shipping and installation cost $1,400. The machine has a 5-year life after which it should have a book value of $5,000 and a market value of $4,000. What is the annual, straight-line depreciation, ignoring the half year convention? $1,400. Reason: Depreciation = ($10,000 + $600 + $1,400 - $5,000)/5 = $1,400 True or false: Since financing costs are included in project WACC, which are used to discount project cash flows, we need to count them as expenses on the project False Free cash flows for which one of the following are affected by estimation error? Project free cash flows only. Reason: Project free cash flows are affected by estimation errors because the cash flows are estimates. Firm free cash flows are actual values. A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed? ($28,000 - $5,000)/5 How can straight-line depreciation be defined? Ignore the half-year convention. Total amount to be depreciated spread evenly over an asset's life. Reason: Depreciation = (Depreciable basis - Ending book value)/Life of asset

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The values for the first year of a project are: Expected sales of 280 units, a selling price of $46, fixed costs of $3,100, depreciation of $1,100, variable cost per unit of $28, and a tax rate of 35 percent. What is the OCF? $1,646. Reason: OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646 Ty's purchased a machine costing $11,000 and paid $660 in sales tax. Shipping and installation cost $1,500. The machine has a 3-year life after which it should have a book value of $3,500 and a market value of $5,000. What is the annual, straight-line depreciation, ignoring the half year convention? $3,220. Reason: Depreciation = ($11,000 + $660 + $1,500 - $3,500)/3 = $3,220 Why are financing costs excluded from project cash flows? Financing costs are included in the required return used to discount project cash flows. Suppose a project has an EBIT of -$1,500. If the tax rate is 21%, what are the computed taxes? Negative $315 What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention.

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($28,000 + $2,000 - $5,000)/6 Values for the first year of a project are projected as: Sales = $1,800, Depreciation = $300, Fixed costs = $450, Variable costs = $620, Tax rate = 34 percent. What is the OCF? $583.80. Reason: OCF = ($1,800 - $620 - $450 - $300)(1 - 0.34) + $300 = $583.80 Manor's purchases some equipment in preparation for a new project. Which of these are time zero cash flows for that project? Select all that apply. Shipping costs to have the equipment delivered Installation and initial testing costs Purchase price of the equipment How are taxes computed when a project's EBIT is negative? The tax rate is multiplied by EBIT producing a tax credit. Free cash flows for which one of the following are affected by estimation error? Project free cash flows only What types of activities related to a project's fixed assets can create a cash flow for the final year of a project? Select all that apply. Trading in the project's equipment on new equipment for other projects. Scrapping equipment that has a positive book value but no market value. Selling the project's equipment.

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A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed? ($28,000 - $5,000)/5 The values for the first year of a project are: Expected sales of 280 units, a selling price of $46, fixed costs of $3,100, depreciation of $1,100, variable cost per unit of $28, and a tax rate of 35 percent. What is the OCF? $1,646. Reason: OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646 How is the gain or loss on a sale of equipment determined? Market value - Book value Which one of these represents a time zero project cash flow? Purchase of new equipment to start a project Suppose a project has an EBIT of -$1,500. If the tax rate is 21%, what are the computed taxes? Negative $315 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185.

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Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 What two conditions must exist for equipment to have no effect on a project's final cash flows? Select two. Assume there are no disposal costs. Zero market value Zero book value A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention. ($28,000 + $2,000 - $5,000)/6 A firm purchased equipment at a total cost of $287,000, which was depreciated straight-line over seven years. After five years, the equipment was sold for $98,900. What is the ATCF at a tax rate of 34 percent? $93,154. Reason: Book value = $287,000 - (5/7 × $287,000) = $82,000; ATCF = $82,000 + ($98,900 - $82,000)(1 - 0.34) = $93,154 Which one of these explains the after-tax cash flow formula for the sale of an asset? The cash flow equals the book value plus the after-tax value of any gain or loss on the sale. Manor's purchases some equipment in preparation for a new project. Which of these are time zero cash flows for that project? Select all that apply. Purchase price of the equipment Installation and initial testing costs Shipping costs to have the equipment delivered

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In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100 What types of activities related to a project's fixed assets can create a cash flow for the final year of a project? Select all that apply. Scrapping equipment that has a positive book value but no market value Trading in the project's equipment on new equipment for other projects Selling the project's equipment A project has a 3-year life and annual sales projections of $120,000, $160,000 and $190,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 5 percent of the next year's sales. How is this requirement handled in project analysis? Select all that apply. A cash inflow of (0.05 × $190,000) occurs in year 3. A cash outflow of [0.05 × ($160,000 - $120,000)] is recorded in year 1. A cash outflow of (0.05 × $120,000) is recorded at time zero. A firm purchased equipment at a total cost of $300,000, which was depreciated straight-line over six years. After six years, the equipment was sold for $100,000. What is the ATCF at a tax rate of 21%? $79,000. Reason: Book value = $300,000 - (6/6 × $300,000) = $0; ATCF = $0 + ($100,000 - $0)(1 - 0.21) = $79,000

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How is the gain or loss on a sale of equipment determined? Market value - Book value A project requires $21,000 of net working capital (NWC) over its 4-year life. Which one of these is correct? There is no cash flow for NWC in years 1 to 3. Which one of these represents a time zero project cash flow? Purchase of new equipment to start a project A new project requires $24,000 of equipment which will be depreciated straight-line to zero over the project's 4-year life. The project requires $2,400 of NWC, the annual OCF is $16,000, and the tax rate is 35 percent. The equipment's market value at the end of year 4 is $5,000. What cash flows occur in year 4? Select all that apply. $5,000 × (1 - 0.35) $2,400 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 If you add all the cash flows related to net working capital (NWC) over a project's life, what sum must you obtain if your cash flows are correct? Zero.

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Reason: Over the life of a project, the NWC cash flows must sum to zero as NWC is returned to its pre- project level when a project ends. A firm purchased equipment at a total cost of $287,000, which was depreciated straight-line over seven years. After five years, the equipment was sold for $98,900. What is the ATCF at a tax rate of 34 percent? $93,154. Reason: Book value = $287,000 - (5/7 × $287,000) = $82,000; ATCF = $82,000 + ($98,900 - $82,000)(1 - 0.34) = $93,154 A project has projected annual sales of $96,000, $112,000 and $136,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 6 percent of the following year's sales. Which of these are correct cash flows for this project? Cash outflow of $1,440 in year 2. Reason: Year 2 cash outflow = 0.06 × ($136,000 - $112,000) = $1,440 A project has a 3-year life and requires equipment costing $34,000. The OCF is estimated at $16,000 annually. NWC of $3,500 is required over the project's life. What cash flows occur at time zero? Select all that apply. -$34,000 -$3,500 In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100

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A project requires $15,000 of net working capital throughout its 5-year life. How is this requirement handled in project analysis? Select all that apply. $15,000 is a cash inflow in year 5. $15,000 is a cash outflow at time zero. A firm purchased equipment at a total cost of $300,000, which was depreciated straight-line over six years. After six years, the equipment was sold for $100,000. What is the ATCF at a tax rate of 21%? $79,000. Reason: Book value = $300,000 - (6/6 × $300,000) = $0; ATCF = $0 + ($100,000 - $0)(1 - 0.21) = $79,000 A project has a 2-year life, net income of $14,500 a year, and a tax rate of 34 percent. The project requires $6,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $2,500 at the end of year 2. The NWC requirement is $1,500. What is the total cash flow for year 2? $20,330. Reason: OCF = $14,500 + ($6,000/3) = $16,500; Book value at the end of year 2 = $6,000/3 = $2,000; ATCF = $2,000 + ($2,500 - $2,000)(1 - 0.34) = $2,330; Year 2 cash flow = $16,500 + $1,500 + $2,330 = $20,330 A project requires $21,000 of net working capital (NWC) over its 4-year life. Which one of these is correct? There is no cash flow for NWC in years 1 to 3. A new project requires $24,000 of equipment which will be depreciated straight-line to zero over the project's 4-year life. The project requires $2,400 of NWC, the annual OCF is $16,000, and the tax rate is 35 percent. The equipment's market value at the end of year 4 is $5,000. What cash flows occur in year 4? Select all that apply. $5,000 × (1 - 0.35)

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$2,400 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 If you add all the cash flows related to net working capital (NWC) over a project's life, what sum must you obtain if your cash flows are correct? Zero The half-year convention is based on which of these assumptions? All assets placed in service during a given period were placed in service at the mid-point of the period A project has a 3-year life, net income of $10,000 a year, and a tax rate of 21%. The project requires $9,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $3,000 at the end of year 3. The NWC requirement is $1,500 which is returned at the end of year 3. What is the total cash flow for year 3? $16,871. Reason: OCF = $10,000 + ($9,000/3) = $13,000; Book value at the end of year 3 = $0 ATCF = $0 + ($3,000 - $0)(1 - 0.21) = $2,371 Year 2 cash flow = $13,000 + $1,500 + $2,371 = $16,871 A project has projected annual sales of $96,000, $112,000 and $136,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 6 percent of the following year's sales. Which of these are correct cash flows for this project?

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Cash outflow of $1,440 in year 2. Reason: Year 2 cash outflow = 0.06 × ($136,000 - $112,000) = $1,440 An asset has a 3-year life and a depreciable basis of $16,400. What is the depreciation in year 4 given straight-line depreciation with half-year convention. The depreciation table percentages are 16.67, 33.33, 33.33, and 16.67 percent for years 1 to 4, respectively. $2,733.88. Reason: Depreciation Year 4 = 0.1667 × $16,400 = $2,733.88 A project has a 3-year life and requires equipment costing $34,000. The OCF is estimated at $16,000 annually. NWC of $3,500 is required over the project's life. What cash flows occur at time zero? Select all that apply. -$34,000 -$3,500 What is the double-declining balance (DDB) method of depreciation? The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value. In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100

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Which one of these is a feature of MACRS depreciation? Depreciation commences with an accelerated method and later switches to a straight-line method. Over how many tax years will a 3-year asset be depreciated given the half-year convention? 4 years A project has a 2-year life, net income of $14,500 a year, and a tax rate of 34 percent. The project requires $6,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $2,500 at the end of year 2. The NWC requirement is $1,500. What is the total cash flow for year 2? $20,330. Reason: OCF = $14,500 + ($6,000/3) = $16,500; Book value at the end of year 2 = $6,000/3 = $2,000; ATCF = $2,000 + ($2,500 - $2,000)(1 - 0.34) = $2,330; Year 2 cash flow = $16,500 + $1,500 + $2,330 = $20,330 An asset has an initial cost of $43,000 and is classified as 3- year MACRS property. The MACRS percentages are 33.33, 44.45, 14.81, and 7.41 percent for years 1 through 4, respectively. What is the depreciation for year 3? $6,368.30. Reason: Depreciation Year 3 = 0.1481 × $43,000 = $6,368.30 An asset has a 4-year life and a depreciable basis of $12,000. What is the first year's depreciation given the straight-line method with half-year convention? The depreciation table percentages are 12.5, 25, 25, 25, and 12.5 for years 1 through 5, respectively. $1,500. Reason: Depreciation Year 1 = 0.125 × $12,000 = $1,500

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What does accelerated depreciation indicate? Depreciation in the first half of an asset's life is greater. Why would a firm prefer to use MACRS rather than straight-line depreciation for tax purposes? The tax deduction from depreciation is greater in the early years. The half-year convention is based on which of these assumptions? All assets placed in service during a given period were placed in service at the mid-point of the period. How do Section 179 deductions aid small businesses? Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase. An asset cost $52,000, has a 5-year MACRS life, and a current book value of $41,600. The MACRS percentages for years 1 to 6 are 20, 32, 19.2, 11.52, 11.52, and 5.76 percent, respectively. What is the depreciation for year 2? $16,640. Reason: Depreciation Year 2 = 0.32 × $52,000 = $16,640 An asset has a 3-year life and a depreciable basis of $16,400. What is the depreciation in year 4 given straight-line depreciation with half-year convention. The depreciation table percentages are 16.67, 33.33, 33.33, and 16.67 percent for years 1 to 4, respectively. $2,733.88. Reason: Depreciation Year 4 = 0.1667 × $16,400 = $2,733.88

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Which of these are properties eligible for a Section 179 deduction? Select all that apply. Machinery purchased by a firm Most storage facilities built by a firm What is the double-declining balance (DDB) method of depreciation? The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value. An asset is 5-year MACRS property and has an initial cost of $64,200. The MACRS percentages are: 20, 32, 19.2, 11.52, 11.52, and 5.76 percent for years 1 to 6, respectively. What is the book value at the end of year 4? $11,093.76. Reason: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76 Which of these correctly apply to MACRS depreciation? Select all that apply. All of the MACRS percentages found in the IRS tables are applied to an asset's initial depreciable basis. MACRS uses DDB for 3- to 10-year property and then switches to SL when SL produces a higher depreciation value. MACRS tables are provided by the IRS. Which one of these represents a limit placed on Section 179 deductions? Taxable income from the active conduct of the firm An asset has an initial cost of $43,000 and is classified as 3- year MACRS property. The MACRS percentages are 33.33, 44.45, 14.81, and 7.41 percent for years 1 through 4, respectively. What is the depreciation for year 3?

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$6,368.30. Reason: Depreciation Year 3 = 0.1481 × $43,000 = $6,368.30 Which one of these is property eligible for a Section 179 deduction? A cow barn that you build on your farm According to the time value of money, what increases if an asset it depreciated as quickly as possible? Present Value of the Income Tax Shield An asset has a depreciable basis of $13,200 and qualifies as 3-year MACRS property. The MACRS percentages are: 16.67, 33.33, 33.33. and 16.67 percent for years 1 to 4, respectively. What is the year 3 ending book value? $2,200.44. Reason: Book value3 = $13,200 × (1 - 0.1667 - 0.3333 - 0.3333) = $2,200.44 Which one of these is a feature of MACRS depreciation? Depreciation commences with an accelerated method and later switches to a straight-line method. A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 4? $880 Reason: The existing asset will be fully depreciated in year 3 so there is no foregone depreciation in year 4. Depreciation4 = $15,400/5 = $3,080

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How do Section 179 deductions aid small businesses? Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase. How can a replacement problem be defined? Buying a new asset which will be used in place of an existing asset that is still usable An asset cost $52,000, has a 5-year MACRS life, and a current book value of $41,600. The MACRS percentages for years 1 to 6 are 20, 32, 19.2, 11.52, 11.52, and 5.76 percent, respectively. What is the depreciation for year 2? $16,640. Reason: Depreciation Year 2 = 0.32 × $52,000 = $16,640 An asset with a remaining book value of $138 is sold for $96. How is the after-tax cash flow (ATCF) computed if the tax rate is 35 percent? ATCF = $138 + ($96 - $138)(1 - 0.35) Assume a firm has a tax rate of 34 percent which remains stable from year to year. Which type of depreciation should the firm use when computing its taxes? MACRS with half-year convention An asset is 5-year MACRS property and has an initial cost of $64,200. The MACRS percentages are: 20, 32, 19.2, 11.52, 11.52, and 5.76 percent for years 1 to 6, respectively. What is the book value at the end of year 4? $11,093.76.

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Reason: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76 What typifies a cost-cutting project? No revenue is generated by the project. A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 2? $880. Reason: Depreciation2 = ($15,400/5) - $2,200 = $880 Which of these are cash flows that apply to a replacement problem? Select all that apply. Cost of new asset ATCF of an existing asset at its normal life-end Depreciation lost if existing asset is sold New equipment was purchased for a project at a total cost of $210,000 and was depreciated straight-line over five years. The equipment was sold at the end of three years for $68,000. How is the ATCF computed using a tax rate of 34 percent? Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) According to the time value of money, what increases if an asset it depreciated as quickly as possible? Present Value of the Income Tax Shield

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A cost-cutting project is least apt to affect which one of these? Revenue A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 4? $3,080. Reason: The existing asset will be fully depreciated in year 3 so there is no foregone depreciation in year 4. Depreciation4 = $15,400/5 = $3,080 How can a replacement problem be defined? Buying a new asset which will be used in place of an existing asset that is still usable A new machine will cost $820,000 and will replace an existing machine. The new machine will reduce variable costs by $170,000 per year. The incremental depreciation is $38,000 and the tax rate is 34 percent. What is the year 2 OCF? $125,120. Reason: EBIT = $170,000 - $38,000 = $132,000; OCF = $132,000(1 - 0.34) + $38,000 = $125,120 An asset with a remaining book value of $138 is sold for $96. How is the after-tax cash flow (ATCF) computed if the tax rate is 35 percent? ATCF = $138 + ($96 - $138)(1 - 0.35) Assume a firm has a tax rate of 34 percent which remains stable from year to year. Which type of depreciation should the firm use when computing its taxes?

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MACRS with half-year convention Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply. Both assets may produce the same level of sales. Two assets can be used for the same purpose What typifies a cost-cutting project? No revenue is generated by the project. In essence, the EAC process makes a decision based on which one of these? Perpetuity payment amount A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 2? $880. Reason: Depreciation2 = ($15,400/5) - $2,200 = $880 What is the second step of the EAC process? Find the annuity payment that has the same present value as the sum of the present values of a project's cash flows

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A machine costing $79,000 will replace an old machine and lower annual variable costs by $15,500 over its 5-year life. The new machine will be depreciated using MACRS with rates of 33.33, 44.45, 14.81, and 7.41 percent for years 1 to 4, respectively. The old machine has a current book value of $39,600 and depreciation of $13,200. What is the incremental depreciation for year 3? -$1,500.10. Reason: Incremental depreciation3 = ($79,000 × 0.1481) - $13,200 = -$1,500.10 New equipment was purchased for a project at a total cost of $210,000 and was depreciated straight-line over five years. The equipment was sold at the end of three years for $68,000. How is the ATCF computed using a tax rate of 34 percent? Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) An asset has a 4-year life and a sum of present values (NPV) of cash flows of -$46,900. The discount rate is 12 percent. How is the equivalent annuity payment, or EAC, computed? N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT Which one of these is a key assumption in situations where EAC is used as the decision method? Whenever the chosen asset wears out, it will be replaced with an identical asset. Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable? Which asset will produce the least negative EAC? What is the first step in the EAC process? Find the sum of the present values of the cash flows for one iteration of each project

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A machine costs $112,000, has a 2-year life and annual after-tax net expenses of $31,400. What is the EAC at rate of 14 percent? -$99,416.45. Reason: NPV = -$112,000 - $31,400/1.14 - $31,400/1.142 = -$163,705.14; N = 2, I = 14, PV = 163,705.14, FV = 0, CPT PMT; PMT = -99,416.45 A new machine will cost $820,000 and will replace an existing machine. The new machine will reduce variable costs by $170,000 per year. The incremental depreciation is $38,000 and the tax rate is 34 percent. What is the year 2 OCF? $125,120. Reason: EBIT = $170,000 - $38,000 = $132,000; OCF = $132,000(1 - 0.34) + $38,000 = $125,120 A machine has an initial cost of $32,000 and annual after-tax net expenses of $2,600. The life of the machine is three years, after which the machine will be worthless. The discount rate is 13 percent. How is the sum of the present values (NPV) of the machine's cash flows calculated? NPV = -$32,000 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133 Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply. Two assets can be used for the same purpose Both assets may produce the same level of sales. In essence, the EAC process makes a decision based on which one of these? Perpetuity payment amount

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A new asset costs $47,000, has a 3-year life, and annual after-tax net expenses of $3,700. What is the EAC at a discount rate of 11 percent? -$22,933.01. Reason: NPV = -$47,000 - $3,700/1.11 - $3,700/1.112 - $3,700/1.113 = -$56,041.74; N = 3, I = 11, PV = 56,041.74, FV = 0, CPT PMT; PMT = -22,933.01 A machine costing $79,000 will replace an old machine and lower annual variable costs by $15,500 over its 5-year life. The new machine will be depreciated using MACRS with rates of 33.33, 44.45, 14.81, and 7.41 percent for years 1 to 4, respectively. The old machine has a current book value of $39,600 and depreciation of $13,200. What is the incremental depreciation for year 3? -$1,500.10 Reason: Incremental depreciation3 = ($79,000 × 0.1481) - $13,200 = -$1,500.10 You are comparing Machine A with a 3-year life and an EAC of -$21,407 and Machine B with a 4-year life and an EAC of -$22,013, Which machine, if either, should be accepted according to the EAC decision criteria? Accept Machine A An asset has a 4-year life and a sum of present values (NPV) of cash flows of -$46,900. The discount rate is 12 percent. How is the equivalent annuity payment, or EAC, computed? N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT Assume the initial costs of a project, CF0, are $38,000 and the weighted average flotation cost, fA, is 6.7 percent. How is the flotation-adjusted CF0 computed? $38,000/(1 - 0.067) Reason: Adjusted CF0 = $38,000/(1 - 0.067)

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Which one of these is a key assumption in situations where EAC is used as the decision method? Whenever the chosen asset wears out, it will be replaced with an identical asset. A firm has a target capital structure of 60 percent equity and 40 percent debt. The flotation cost of equity is 13 percent while it is 9 percent for debt. The initial cost of a project is $468,000. What is the flotation-adjusted cash flow for time zero? $528,217. Reason: fA = (0.6 × 0.13) + (0.4 × 0.09) = 0.114 Adjusted CF0 = $468,000/(1 - 0.114) = $528,217 Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable? Which asset will produce the least negative EAC? How is free cash flow defined? Cash flow available for distribution to a firm's investors A machine costs $112,000, has a 2-year life and annual after-tax net expenses of $31,400. What is the EAC at rate of 14 percent? -$99,416.45. Reason: NPV = -$112,000 - $31,400/1.14 - $31,400/1.142 = -$163,705.14; N = 2, I = 14, PV = 163,705.14, FV = 0, CPT PMT; PMT = -99,416.45 You are comparing Machine A with a 7-year life and an EAC of -$20,050 and Machine B with a 2-year life and an EAC of -$22,000. Which machine, if either, should be accepted according to the EAC decision criteria?

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Accept Machine A Why are a firm's target capital structure values used in computing the average flotation cost? The firm will issue securities in these percentages over the long term. A firm has a target capital structure of 50 percent equity, 10 percent preferred, and 40 percent debt. Their respective flotation costs are 12 percent, 10 percent, and 7 percent. What is the weighted average flotation cost? 9.80 percent. Reason: fA = (0.5 × 0.12) + (0.1 × 0.10) + (0.4 × 0.07) = 0.0980 = 9.80% Which of these correctly define free cash flow? FCF = [EBIT(1 - Tax rate) + Depreciation] - [Change in gross fixed assets + Change in net operating working capital] FCF = OCF - Investment in operating capital A new asset costs $47,000, has a 3-year life, and annual after-tax net expenses of $3,700. What is the EAC at a discount rate of 11 percent? -$22,933.01. Reason: NPV = -$47,000 - $3,700/1.11 - $3,700/1.112 - $3,700/1.113 = -$56,041.74; N = 3, I = 11, PV = 56,041.74, FV = 0, CPT PMT; PMT = -22,933.01 You are comparing Machine A with a 3-year life and an EAC of -$21,407 and Machine B with a 4-year life and an EAC of -$22,013, Which machine, if either, should be accepted according to the EAC decision criteria? Accept machine A

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What is the first step in the process of adjusting the initial investment for flotation costs? Compute the weighted average flotation cost using the target capital weights A firm has a target capital structure of 60 percent equity and 40 percent debt. The flotation cost of equity is 13 percent while it is 9 percent for debt. The initial cost of a project is $468,000. What is the flotation-adjusted cash flow for time zero? $528,217. Reason: fA = (0.6 × 0.13) + (0.4 × 0.09) = 0.114 Adjusted CF0 = $468,000/(1 - 0.114) = $528,217 How is free cash flow defined? Cash flow available for distribution to a firm's investors Assume the initial costs of a project, CF0, are $38,000 and the weighted average flotation cost, fA, is 6.7 percent. How is the flotation-adjusted CF0 computed? $38,000/(1 - 0.067) Reason: Adjusted CF0 = $38,000/(1 - 0.067) A firm has a target capital structure of 50 percent equity, 10 percent preferred, and 40 percent debt. Their respective flotation costs are 12 percent, 10 percent, and 7 percent. What is the weighted average flotation cost? 9.80 percent. Reason: fA = (0.5 × 0.12) + (0.1 × 0.10) + (0.4 × 0.07) = 0.0980 = 9.80%

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True or false: Net working capital is a measure of a firm's ability to pay its bills within a year. True What is pro forma analysis? Estimation of future project cash flows using only the relevant parts of the financial statements What is an incremental cash flow? A cash flow that either increases or decreases when a new project is implemented Which one of these represents an opportunity cost? Assigning a current employee to a new project Should opportunity costs be included in or excluded from project analysis? Why? Included; The firm must forego using the resource in any other way, thereby incurring a cost. What is the definition of net working capital? Net working capital is the difference between a firm's current assets and current liabilities. What is a sunk cost? A previously incurred cost that cannot be recovered

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In pro forma analysis, what determines whether or not an account on the balance sheet or income statement is relevant to a project? If the project causes an account value to change, then it is relevant. How can you determine if a cash flow is incremental to a project? Select all that apply. The cash flow will disappear when the project ceases. The cash flow occurs only if a new project is implemented. The cash flow changes only when a new project is implemented. Which of these represent opportunity costs? Select all that apply. Using a piece of company equipment that has been sitting idle for two years in a new project. Building a new building on a vacant lot owned by the firm. Using a current employee who is about to be laid off to run a project on a day by day basis. Opportunity costs are costs incurred when resources owned or employed by a firm have which one these characteristics? Multiple uses How can a sunk cost be recovered? Sunk costs cannot be recovered. What is pro forma analysis? Estimation of future project cash flows using only the relevant parts of the financial statements

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Why are sunk costs excluded from project analysis? The costs have been incurred and cannot be recouped with or without the project. What is an incremental cash flow? A cash flow that either increases or decreases when a new project is implemented Leo's currently sells $5,000 of wood toys and $2,000 of metal toys. Leo's wants to begin selling plastic toys. If it does, the expected sales are $7,500 of wood toys, $2,500 of metal toys, and $3,500 of plastic toys. What is the value of the complementary effect of the plastic toys? $3,000. Reason: Complementary effect = ($7,500 - $5,000) + ($2,500 - $2,000) = $3,000 Which one of these represents an opportunity cost? Assigning a current employee to a new project Which of these is the best description of the substitution effect? Any decrease in the level of sales, costs, or necessary assets of a firm's current operations that is caused by the implementation of a new project. Reason: This answer defines a complementary effect. Substitute effects are decreases in current sales or costs caused by a new project. Should opportunity costs be included in or excluded from project analysis? Why? Included; The firm must forego using the resource in any other way, thereby incurring a cost.

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What is a sunk cost? A previously incurred cost that cannot be recovered. Which of these illustrates a complementary effect? Select all that apply. A new product increases the sales of one of the firm's existing products. A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products. Mike's Garage spent $1,000 last week to repair its parking lot. No matter what Mike does, he cannot recoup this expense for his business. What type of cost is this? Sunk cost What is a financing cost? Interest and dividends paid as a result of external financing Krista's Place sells $15,000 of art work and $12,000 of craft supplies. If Krista's add home accessories, the projected sales become $12,000 of art work, $9,000 of craft supplies, and $13,000 of home accessories. What is the substitution effect of the home accessories? -$6,000. Reason: Substitution effect = ($12,000 -$15,000) + ($9,000 - $12,000) = -$6,000 How is a complementary effect defined? Any increase in the current level of sales, costs, or necessary assets of a firm's existing operations caused by a new project

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What is an opportunity cost? The value of the next best alternative use of a resource owned or employed by a firm Which one of these is an example of the substitution effect? Current employee costs are lowered due to the automation processes implemented by a new project Which of these are financing costs? Select all that apply. Bond interest Stock dividend Leo's currently sells $5,000 of wood toys and $2,000 of metal toys. Leo's wants to begin selling plastic toys. If it does, the expected sales are $7,500 of wood toys, $2,500 of metal toys, and $3,500 of plastic toys. What is the value of the complementary effect of the plastic toys? $3,000. Reason: Complementary effect = ($7,500 - $5,000) + ($2,500 - $2,000) = $3,000 Which of these is the best description of the substitution effect? Any decrease in the level of sales, costs, or necessary assets of a firm's current operations that is caused by the implementation of a new project Opportunity costs are costs incurred when resources owned or employed by a firm have which one these characteristics? Multiple uses

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How is bond interest included in the analysis of a new project? Bond interest is included in the computation of a bond's yield to maturity, which is the pretax cost of debt used to compute a project's WACC Which of these illustrates a complementary effect? Select all that apply. A new product increases the sales of one of the firm's existing products. A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products. Why are financing costs excluded from project cash flows? Financing costs are included in the required return used to discount project cash flows. What is a financing cost? Interest and dividends paid as a result of external financing What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. Krista's Place sells $15,000 of art work and $12,000 of craft supplies. If Krista's add home accessories, the projected sales become $12,000 of art work, $9,000 of craft supplies, and $13,000 of home accessories. What is the substitution effect of the home accessories? -$6,000.

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Reason: Substitution effect = ($12,000 -$15,000) + ($9,000 - $12,000) = -$6,000 What types of costs are included in an asset's depreciable basis? Select all that apply. Installation and testing costs Sales tax and freight charges Purchase price of the asset How is a complementary effect defined? Any increase in the current level of sales, costs, or necessary assets of a firm's existing operations caused by a new project Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention. (Depreciable basis - Ending book value)/Life of asset How are the dividends paid on stock included in the analysis of a new project? Financing costs, such as dividends, are considered in the component costs of capital when a project's WACC is calculated. True or false: Since financing costs are included in project WACC, which are used to discount project cash flows, we need to count them as expenses on the project False Free cash flows for which one of the following are affected by estimation error?

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Project free cash flows only McGinty's purchased a new machine for $318,000, paid $19,000 in sales tax, and $7,500 in delivery charges. The firm paid $3,400 to have the machine calibrated once it was set in place. The machine requires $5,600 of annual maintenance. What is the depreciable basis of the machine? Multiple choice question. $347,900. Reason: Depreciable basis = $318,000 + $19,000 + $7,500 + $3,400 = $347,900 A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed? ($28,000 - $5,000)/5 How can straight-line depreciation be defined? Ignore the half-year convention. Total amount to be depreciated spread evenly over an asset's life How is bond interest included in the analysis of a new project? Bond interest is included in the computation of a bond's yield to maturity, which is the pretax cost of debt used to compute a project's WACC Why are financing costs excluded from project cash flows? Financing costs are included in the required return used to discount project cash flows.

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What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention. ($28,000 + $2,000 - $5,000)/6 Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention. (Depreciable basis - Ending book value)/Life of asset The Foster House purchased a machine costing $10,000 and paid $600 in sales tax. Shipping and installation cost $1,400. The machine has a 5-year life after which it should have a book value of $5,000 and a market value of $4,000. What is the annual, straight-line depreciation, ignoring the half year convention? $1,400. Reason: Depreciation = ($10,000 + $600 + $1,400 - $5,000)/5 = $1,400 True or false: Since financing costs are included in project WACC, which are used to discount project cash flows, we need to count them as expenses on the project False Free cash flows for which one of the following are affected by estimation error? Project free cash flows only.

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Reason: Project free cash flows are affected by estimation errors because the cash flows are estimates. Firm free cash flows are actual values. A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed? ($28,000 - $5,000)/5 How can straight-line depreciation be defined? Ignore the half-year convention. Total amount to be depreciated spread evenly over an asset's life. Reason: Depreciation = (Depreciable basis - Ending book value)/Life of asset The values for the first year of a project are: Expected sales of 280 units, a selling price of $46, fixed costs of $3,100, depreciation of $1,100, variable cost per unit of $28, and a tax rate of 35 percent. What is the OCF? $1,646. Reason: OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646 Ty's purchased a machine costing $11,000 and paid $660 in sales tax. Shipping and installation cost $1,500. The machine has a 3-year life after which it should have a book value of $3,500 and a market value of $5,000. What is the annual, straight-line depreciation, ignoring the half year convention? $3,220. Reason: Depreciation = ($11,000 + $660 + $1,500 - $3,500)/3 = $3,220 Why are financing costs excluded from project cash flows? Financing costs are included in the required return used to discount project cash flows.

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Suppose a project has an EBIT of -$1,500. If the tax rate is 21%, what are the computed taxes? Negative $315 What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention. ($28,000 + $2,000 - $5,000)/6 Values for the first year of a project are projected as: Sales = $1,800, Depreciation = $300, Fixed costs = $450, Variable costs = $620, Tax rate = 34 percent. What is the OCF? $583.80. Reason: OCF = ($1,800 - $620 - $450 - $300)(1 - 0.34) + $300 = $583.80 Manor's purchases some equipment in preparation for a new project. Which of these are time zero cash flows for that project? Select all that apply. Shipping costs to have the equipment delivered Installation and initial testing costs Purchase price of the equipment

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How are taxes computed when a project's EBIT is negative? The tax rate is multiplied by EBIT producing a tax credit. Free cash flows for which one of the following are affected by estimation error? Project free cash flows only What types of activities related to a project's fixed assets can create a cash flow for the final year of a project? Select all that apply. Trading in the project's equipment on new equipment for other projects. Scrapping equipment that has a positive book value but no market value. Selling the project's equipment. A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed? ($28,000 - $5,000)/5 The values for the first year of a project are: Expected sales of 280 units, a selling price of $46, fixed costs of $3,100, depreciation of $1,100, variable cost per unit of $28, and a tax rate of 35 percent. What is the OCF? $1,646. Reason: OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646 How is the gain or loss on a sale of equipment determined? Market value - Book value

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Which one of these represents a time zero project cash flow? Purchase of new equipment to start a project Suppose a project has an EBIT of -$1,500. If the tax rate is 21%, what are the computed taxes? Negative $315 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 What two conditions must exist for equipment to have no effect on a project's final cash flows? Select two. Assume there are no disposal costs. Zero market value Zero book value A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention. ($28,000 + $2,000 - $5,000)/6

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A firm purchased equipment at a total cost of $287,000, which was depreciated straight-line over seven years. After five years, the equipment was sold for $98,900. What is the ATCF at a tax rate of 34 percent? $93,154. Reason: Book value = $287,000 - (5/7 × $287,000) = $82,000; ATCF = $82,000 + ($98,900 - $82,000)(1 - 0.34) = $93,154 Which one of these explains the after-tax cash flow formula for the sale of an asset? The cash flow equals the book value plus the after-tax value of any gain or loss on the sale. Manor's purchases some equipment in preparation for a new project. Which of these are time zero cash flows for that project? Select all that apply. Purchase price of the equipment Installation and initial testing costs Shipping costs to have the equipment delivered In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100 What types of activities related to a project's fixed assets can create a cash flow for the final year of a project? Select all that apply. Scrapping equipment that has a positive book value but no market value Trading in the project's equipment on new equipment for other projects Selling the project's equipment

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A project has a 3-year life and annual sales projections of $120,000, $160,000 and $190,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 5 percent of the next year's sales. How is this requirement handled in project analysis? Select all that apply. A cash inflow of (0.05 × $190,000) occurs in year 3. A cash outflow of [0.05 × ($160,000 - $120,000)] is recorded in year 1. A cash outflow of (0.05 × $120,000) is recorded at time zero. A firm purchased equipment at a total cost of $300,000, which was depreciated straight-line over six years. After six years, the equipment was sold for $100,000. What is the ATCF at a tax rate of 21%? $79,000. Reason: Book value = $300,000 - (6/6 × $300,000) = $0; ATCF = $0 + ($100,000 - $0)(1 - 0.21) = $79,000 How is the gain or loss on a sale of equipment determined? Market value - Book value A project requires $21,000 of net working capital (NWC) over its 4-year life. Which one of these is correct? There is no cash flow for NWC in years 1 to 3. Which one of these represents a time zero project cash flow? Purchase of new equipment to start a project

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A new project requires $24,000 of equipment which will be depreciated straight-line to zero over the project's 4-year life. The project requires $2,400 of NWC, the annual OCF is $16,000, and the tax rate is 35 percent. The equipment's market value at the end of year 4 is $5,000. What cash flows occur in year 4? Select all that apply. $5,000 × (1 - 0.35) $2,400 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 If you add all the cash flows related to net working capital (NWC) over a project's life, what sum must you obtain if your cash flows are correct? Zero. Reason: Over the life of a project, the NWC cash flows must sum to zero as NWC is returned to its pre- project level when a project ends. A firm purchased equipment at a total cost of $287,000, which was depreciated straight-line over seven years. After five years, the equipment was sold for $98,900. What is the ATCF at a tax rate of 34 percent? $93,154. Reason: Book value = $287,000 - (5/7 × $287,000) = $82,000; ATCF = $82,000 + ($98,900 - $82,000)(1 - 0.34) = $93,154 A project has projected annual sales of $96,000, $112,000 and $136,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 6 percent of the following year's sales. Which of these are correct cash flows for this project?

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Cash outflow of $1,440 in year 2. Reason: Year 2 cash outflow = 0.06 × ($136,000 - $112,000) = $1,440 A project has a 3-year life and requires equipment costing $34,000. The OCF is estimated at $16,000 annually. NWC of $3,500 is required over the project's life. What cash flows occur at time zero? Select all that apply. -$34,000 -$3,500 In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100 A project requires $15,000 of net working capital throughout its 5-year life. How is this requirement handled in project analysis? Select all that apply. $15,000 is a cash inflow in year 5. $15,000 is a cash outflow at time zero. A firm purchased equipment at a total cost of $300,000, which was depreciated straight-line over six years. After six years, the equipment was sold for $100,000. What is the ATCF at a tax rate of 21%? $79,000. Reason: Book value = $300,000 - (6/6 × $300,000) = $0; ATCF = $0 + ($100,000 - $0)(1 - 0.21) = $79,000

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A project has a 2-year life, net income of $14,500 a year, and a tax rate of 34 percent. The project requires $6,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $2,500 at the end of year 2. The NWC requirement is $1,500. What is the total cash flow for year 2? $20,330. Reason: OCF = $14,500 + ($6,000/3) = $16,500; Book value at the end of year 2 = $6,000/3 = $2,000; ATCF = $2,000 + ($2,500 - $2,000)(1 - 0.34) = $2,330; Year 2 cash flow = $16,500 + $1,500 + $2,330 = $20,330 A project requires $21,000 of net working capital (NWC) over its 4-year life. Which one of these is correct? There is no cash flow for NWC in years 1 to 3. A new project requires $24,000 of equipment which will be depreciated straight-line to zero over the project's 4-year life. The project requires $2,400 of NWC, the annual OCF is $16,000, and the tax rate is 35 percent. The equipment's market value at the end of year 4 is $5,000. What cash flows occur in year 4? Select all that apply. $5,000 × (1 - 0.35) $2,400 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 If you add all the cash flows related to net working capital (NWC) over a project's life, what sum must you obtain if your cash flows are correct?

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Zero The half-year convention is based on which of these assumptions? All assets placed in service during a given period were placed in service at the mid-point of the period A project has a 3-year life, net income of $10,000 a year, and a tax rate of 21%. The project requires $9,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $3,000 at the end of year 3. The NWC requirement is $1,500 which is returned at the end of year 3. What is the total cash flow for year 3? $16,871. Reason: OCF = $10,000 + ($9,000/3) = $13,000; Book value at the end of year 3 = $0 ATCF = $0 + ($3,000 - $0)(1 - 0.21) = $2,371 Year 2 cash flow = $13,000 + $1,500 + $2,371 = $16,871 A project has projected annual sales of $96,000, $112,000 and $136,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 6 percent of the following year's sales. Which of these are correct cash flows for this project? Cash outflow of $1,440 in year 2. Reason: Year 2 cash outflow = 0.06 × ($136,000 - $112,000) = $1,440 An asset has a 3-year life and a depreciable basis of $16,400. What is the depreciation in year 4 given straight-line depreciation with half-year convention. The depreciation table percentages are 16.67, 33.33, 33.33, and 16.67 percent for years 1 to 4, respectively. $2,733.88. Reason: Depreciation Year 4 = 0.1667 × $16,400 = $2,733.88

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A project has a 3-year life and requires equipment costing $34,000. The OCF is estimated at $16,000 annually. NWC of $3,500 is required over the project's life. What cash flows occur at time zero? Select all that apply. -$34,000 -$3,500 What is the double-declining balance (DDB) method of depreciation? The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value. In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100. Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100 Which one of these is a feature of MACRS depreciation? Depreciation commences with an accelerated method and later switches to a straight-line method. Over how many tax years will a 3-year asset be depreciated given the half-year convention? 4 years A project has a 2-year life, net income of $14,500 a year, and a tax rate of 34 percent. The project requires $6,000 of equipment which will be depreciated straight-line over 3 years, and have a market

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value of $2,500 at the end of year 2. The NWC requirement is $1,500. What is the total cash flow for year 2? $20,330. Reason: OCF = $14,500 + ($6,000/3) = $16,500; Book value at the end of year 2 = $6,000/3 = $2,000; ATCF = $2,000 + ($2,500 - $2,000)(1 - 0.34) = $2,330; Year 2 cash flow = $16,500 + $1,500 + $2,330 = $20,330 An asset has an initial cost of $43,000 and is classified as 3- year MACRS property. The MACRS percentages are 33.33, 44.45, 14.81, and 7.41 percent for years 1 through 4, respectively. What is the depreciation for year 3? $6,368.30. Reason: Depreciation Year 3 = 0.1481 × $43,000 = $6,368.30 An asset has a 4-year life and a depreciable basis of $12,000. What is the first year's depreciation given the straight-line method with half-year convention? The depreciation table percentages are 12.5, 25, 25, 25, and 12.5 for years 1 through 5, respectively. $1,500. Reason: Depreciation Year 1 = 0.125 × $12,000 = $1,500 What does accelerated depreciation indicate? Depreciation in the first half of an asset's life is greater. Why would a firm prefer to use MACRS rather than straight-line depreciation for tax purposes? The tax deduction from depreciation is greater in the early years. The half-year convention is based on which of these assumptions?

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All assets placed in service during a given period were placed in service at the mid-point of the period. How do Section 179 deductions aid small businesses? Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase. An asset cost $52,000, has a 5-year MACRS life, and a current book value of $41,600. The MACRS percentages for years 1 to 6 are 20, 32, 19.2, 11.52, 11.52, and 5.76 percent, respectively. What is the depreciation for year 2? $16,640. Reason: Depreciation Year 2 = 0.32 × $52,000 = $16,640 An asset has a 3-year life and a depreciable basis of $16,400. What is the depreciation in year 4 given straight-line depreciation with half-year convention. The depreciation table percentages are 16.67, 33.33, 33.33, and 16.67 percent for years 1 to 4, respectively. $2,733.88. Reason: Depreciation Year 4 = 0.1667 × $16,400 = $2,733.88 Which of these are properties eligible for a Section 179 deduction? Select all that apply. Machinery purchased by a firm Most storage facilities built by a firm What is the double-declining balance (DDB) method of depreciation? The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value.

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An asset is 5-year MACRS property and has an initial cost of $64,200. The MACRS percentages are: 20, 32, 19.2, 11.52, 11.52, and 5.76 percent for years 1 to 6, respectively. What is the book value at the end of year 4? $11,093.76. Reason: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76 Which of these correctly apply to MACRS depreciation? Select all that apply. All of the MACRS percentages found in the IRS tables are applied to an asset's initial depreciable basis. MACRS uses DDB for 3- to 10-year property and then switches to SL when SL produces a higher depreciation value. MACRS tables are provided by the IRS. Which one of these represents a limit placed on Section 179 deductions? Taxable income from the active conduct of the firm An asset has an initial cost of $43,000 and is classified as 3- year MACRS property. The MACRS percentages are 33.33, 44.45, 14.81, and 7.41 percent for years 1 through 4, respectively. What is the depreciation for year 3? $6,368.30. Reason: Depreciation Year 3 = 0.1481 × $43,000 = $6,368.30 Which one of these is property eligible for a Section 179 deduction? A cow barn that you build on your farm

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According to the time value of money, what increases if an asset it depreciated as quickly as possible? Present Value of the Income Tax Shield An asset has a depreciable basis of $13,200 and qualifies as 3-year MACRS property. The MACRS percentages are: 16.67, 33.33, 33.33. and 16.67 percent for years 1 to 4, respectively. What is the year 3 ending book value? $2,200.44. Reason: Book value3 = $13,200 × (1 - 0.1667 - 0.3333 - 0.3333) = $2,200.44 Which one of these is a feature of MACRS depreciation? Depreciation commences with an accelerated method and later switches to a straight-line method. A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 4? $3,080. Reason: The existing asset will be fully depreciated in year 3 so there is no foregone depreciation in year 4. Depreciation4 = $15,400/5 = $3,080 How do Section 179 deductions aid small businesses? Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase. How can a replacement problem be defined? Buying a new asset which will be used in place of an existing asset that is still usable

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An asset cost $52,000, has a 5-year MACRS life, and a current book value of $41,600. The MACRS percentages for years 1 to 6 are 20, 32, 19.2, 11.52, 11.52, and 5.76 percent, respectively. What is the depreciation for year 2? $16,640. Reason: Depreciation Year 2 = 0.32 × $52,000 = $16,640 An asset with a remaining book value of $138 is sold for $96. How is the after-tax cash flow (ATCF) computed if the tax rate is 35 percent? ATCF = $138 + ($96 - $138)(1 - 0.35) Assume a firm has a tax rate of 34 percent which remains stable from year to year. Which type of depreciation should the firm use when computing its taxes? MACRS with half-year convention An asset is 5-year MACRS property and has an initial cost of $64,200. The MACRS percentages are: 20, 32, 19.2, 11.52, 11.52, and 5.76 percent for years 1 to 6, respectively. What is the book value at the end of year 4? $11,093.76. Reason: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76 What typifies a cost-cutting project? No revenue is generated by the project.

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A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 2? $880. Reason: Depreciation2 = ($15,400/5) - $2,200 = $880 Which of these are cash flows that apply to a replacement problem? Select all that apply. Cost of new asset ATCF of an existing asset at its normal life-end Depreciation lost if existing asset is sold New equipment was purchased for a project at a total cost of $210,000 and was depreciated straight-line over five years. The equipment was sold at the end of three years for $68,000. How is the ATCF computed using a tax rate of 34 percent? Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) According to the time value of money, what increases if an asset it depreciated as quickly as possible? Present Value of the Income Tax Shield A cost-cutting project is least apt to affect which one of these? Revenue A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 4? $3,080.

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Reason: The existing asset will be fully depreciated in year 3 so there is no foregone depreciation in year 4. Depreciation4 = $15,400/5 = $3,080 How can a replacement problem be defined? Buying a new asset which will be used in place of an existing asset that is still usable A new machine will cost $820,000 and will replace an existing machine. The new machine will reduce variable costs by $170,000 per year. The incremental depreciation is $38,000 and the tax rate is 34 percent. What is the year 2 OCF? $125,120. Reason: EBIT = $170,000 - $38,000 = $132,000; OCF = $132,000(1 - 0.34) + $38,000 = $125,120 An asset with a remaining book value of $138 is sold for $96. How is the after-tax cash flow (ATCF) computed if the tax rate is 35 percent? ATCF = $138 + ($96 - $138)(1 - 0.35) Assume a firm has a tax rate of 34 percent which remains stable from year to year. Which type of depreciation should the firm use when computing its taxes? MACRS with half-year convention Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply. Both assets may produce the same level of sales. Two assets can be used for the same purpose

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What typifies a cost-cutting project? No revenue is generated by the project. In essence, the EAC process makes a decision based on which one of these? Perpetuity payment amount A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 2? $880. Reason: Depreciation2 = ($15,400/5) - $2,200 = $880 What is the second step of the EAC process? Find the annuity payment that has the same present value as the sum of the present values of a project's cash flows A machine costing $79,000 will replace an old machine and lower annual variable costs by $15,500 over its 5-year life. The new machine will be depreciated using MACRS with rates of 33.33, 44.45, 14.81, and 7.41 percent for years 1 to 4, respectively. The old machine has a current book value of $39,600 and depreciation of $13,200. What is the incremental depreciation for year 3? -$1,500.10. Reason: Incremental depreciation3 = ($79,000 × 0.1481) - $13,200 = -$1,500.10 New equipment was purchased for a project at a total cost of $210,000 and was depreciated straight-line over five years. The equipment was sold at the end of three years for $68,000. How is the ATCF computed using a tax rate of 34 percent?

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Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) An asset has a 4-year life and a sum of present values (NPV) of cash flows of -$46,900. The discount rate is 12 percent. How is the equivalent annuity payment, or EAC, computed? N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT Which one of these is a key assumption in situations where EAC is used as the decision method? Whenever the chosen asset wears out, it will be replaced with an identical asset. Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable? Which asset will produce the least negative EAC? What is the first step in the EAC process? Find the sum of the present values of the cash flows for one iteration of each project A machine costs $112,000, has a 2-year life and annual after-tax net expenses of $31,400. What is the EAC at rate of 14 percent? -$99,416.45. Reason: NPV = -$112,000 - $31,400/1.14 - $31,400/1.142 = -$163,705.14; N = 2, I = 14, PV = 163,705.14, FV = 0, CPT PMT; PMT = -99,416.45 A new machine will cost $820,000 and will replace an existing machine. The new machine will reduce variable costs by $170,000 per year. The incremental depreciation is $38,000 and the tax rate is 34 percent. What is the year 2 OCF?

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$125,120. Reason: EBIT = $170,000 - $38,000 = $132,000; OCF = $132,000(1 - 0.34) + $38,000 = $125,120 A machine has an initial cost of $32,000 and annual after-tax net expenses of $2,600. The life of the machine is three years, after which the machine will be worthless. The discount rate is 13 percent. How is the sum of the present values (NPV) of the machine's cash flows calculated? NPV = -$32,000 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133 Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply. Two assets can be used for the same purpose Both assets may produce the same level of sales. In essence, the EAC process makes a decision based on which one of these? Perpetuity payment amount A new asset costs $47,000, has a 3-year life, and annual after-tax net expenses of $3,700. What is the EAC at a discount rate of 11 percent? -$22,933.01. Reason: NPV = -$47,000 - $3,700/1.11 - $3,700/1.112 - $3,700/1.113 = -$56,041.74; N = 3, I = 11, PV = 56,041.74, FV = 0, CPT PMT; PMT = -22,933.01 A machine costing $79,000 will replace an old machine and lower annual variable costs by $15,500 over its 5-year life. The new machine will be depreciated using MACRS with rates of 33.33, 44.45, 14.81, and 7.41 percent for years 1 to 4, respectively. The old machine has a current book value of $39,600 and depreciation of $13,200. What is the incremental depreciation for year 3? -$1,500.10

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Reason: Incremental depreciation3 = ($79,000 × 0.1481) - $13,200 = -$1,500.10 You are comparing Machine A with a 3-year life and an EAC of -$21,407 and Machine B with a 4-year life and an EAC of -$22,013, Which machine, if either, should be accepted according to the EAC decision criteria? Accept Machine A An asset has a 4-year life and a sum of present values (NPV) of cash flows of -$46,900. The discount rate is 12 percent. How is the equivalent annuity payment, or EAC, computed? N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT Assume the initial costs of a project, CF0, are $38,000 and the weighted average flotation cost, fA, is 6.7 percent. How is the flotation-adjusted CF0 computed? $38,000/(1 - 0.067) Reason: Adjusted CF0 = $38,000/(1 - 0.067) Which one of these is a key assumption in situations where EAC is used as the decision method? Whenever the chosen asset wears out, it will be replaced with an identical asset. A firm has a target capital structure of 60 percent equity and 40 percent debt. The flotation cost of equity is 13 percent while it is 9 percent for debt. The initial cost of a project is $468,000. What is the flotation-adjusted cash flow for time zero? $528,217. Reason: fA = (0.6 × 0.13) + (0.4 × 0.09) = 0.114 Adjusted CF0 = $468,000/(1 - 0.114) = $528,217

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Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable? Which asset will produce the least negative EAC? How is free cash flow defined? Cash flow available for distribution to a firm's investors A machine costs $112,000, has a 2-year life and annual after-tax net expenses of $31,400. What is the EAC at rate of 14 percent? -$99,416.45. Reason: NPV = -$112,000 - $31,400/1.14 - $31,400/1.142 = -$163,705.14; N = 2, I = 14, PV = 163,705.14, FV = 0, CPT PMT; PMT = -99,416.45 You are comparing Machine A with a 7-year life and an EAC of -$20,050 and Machine B with a 2-year life and an EAC of -$22,000. Which machine, if either, should be accepted according to the EAC decision criteria? Accept Machine A Why are a firm's target capital structure values used in computing the average flotation cost? The firm will issue securities in these percentages over the long term. A firm has a target capital structure of 50 percent equity, 10 percent preferred, and 40 percent debt. Their respective flotation costs are 12 percent, 10 percent, and 7 percent. What is the weighted average flotation cost? 9.80 percent.

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Reason: fA = (0.5 × 0.12) + (0.1 × 0.10) + (0.4 × 0.07) = 0.0980 = 9.80% Which of these correctly define free cash flow? FCF = [EBIT(1 - Tax rate) + Depreciation] - [Change in gross fixed assets + Change in net operating working capital] FCF = OCF - Investment in operating capital A new asset costs $47,000, has a 3-year life, and annual after-tax net expenses of $3,700. What is the EAC at a discount rate of 11 percent? -$22,933.01. Reason: NPV = -$47,000 - $3,700/1.11 - $3,700/1.112 - $3,700/1.113 = -$56,041.74; N = 3, I = 11, PV = 56,041.74, FV = 0, CPT PMT; PMT = -22,933.01 You are comparing Machine A with a 3-year life and an EAC of -$21,407 and Machine B with a 4-year life and an EAC of -$22,013, Which machine, if either, should be accepted according to the EAC decision criteria? Accept machine A What is the first step in the process of adjusting the initial investment for flotation costs? Compute the weighted average flotation cost using the target capital weights A firm has a target capital structure of 60 percent equity and 40 percent debt. The flotation cost of equity is 13 percent while it is 9 percent for debt. The initial cost of a project is $468,000. What is the flotation-adjusted cash flow for time zero? $528,217. Reason: fA = (0.6 × 0.13) + (0.4 × 0.09) = 0.114

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Adjusted CF0 = $468,000/(1 - 0.114) = $528,217 How is free cash flow defined? Cash flow available for distribution to a firm's investors Assume the initial costs of a project, CF0, are $38,000 and the weighted average flotation cost, fA, is 6.7 percent. How is the flotation-adjusted CF0 computed? $38,000/(1 - 0.067) Reason: Adjusted CF0 = $38,000/(1 - 0.067) A firm has a target capital structure of 50 percent equity, 10 percent preferred, and 40 percent debt. Their respective flotation costs are 12 percent, 10 percent, and 7 percent. What is the weighted average flotation cost? 9.80 percent. Reason: fA = (0.5 × 0.12) + (0.1 × 0.10) + (0.4 × 0.07) = 0.0980 = 9.80% What is pro forma analysis? Estimation of future project cash flows using only the relevant parts of the financial statements What is an incremental cash flow? A cash flow that either increases or decreases when a new project is implemented Which one of these represents an opportunity cost?

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Assigning a current employee to a new project What is an opportunity cost? The value of the next best alternative use of a resource owned or employed by a firm Why are sunk costs excluded from project analysis? The costs have been incurred and cannot be recouped with or without the project. In proforma analysis, what determines whether or not an account on the balance sheet or income statement is relevant to a project? If the project causes an account value to change, then it is relevant. How can you determine if a cash flow is incremental to a project? Select all that apply. The cash flow changes only when a new project is implemented. The cash flow will disappear when the project ceases. The cash flow occurs only if a new project is implemented. Which of these represent opportunity costs? Select all that apply. Using a piece of company equipment that has been sitting idle for two years in a new project Building a new building on a vacant lot owned by the firm

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Using a current employee who is about to be laid off to run a project on a day by day basis Opportunity costs are costs incurred when resources owned or employed by a firm have which one these characteristics? Multiple uses Mike's Garage spent $1,000 last week to repair its parking lot. No matter what Mike does, he cannot recoup this expense for his business. What type of cost is this? Sunk cost Should opportunity costs be included in or excluded from project analysis? Why? Included; The firm must forego using the resource in any other way, thereby incurring a cost. Which one of these is a sunk cost? Development costs of a new project What is a sunk cost? A previously incurred cost than cannot be recovered Krista's Place sells $15,000 of art work and $12,000 of craft supplies. If Krista's add home accessories, the projected sales become $12,000 of art work, $9,000 of craft supplies, and $13,000 of home accessories. What is the substitution effect of the home accessories? -$6,000 Rationale:

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Substitution effect = ($12,000 -$15,000) + ($9,000 - $12,000) = -$6,000 Which one of these is an example of the substitution effect? Current employee costs are lowered due to the automation processes implemented by a new project How can a sunk cost be recovered? Sunk costs cannot be recovered. Leo's currently sells $5,000 of wood toys and $2,000 of metal toys. Leo's wants to begin selling plastic toys. If it does, the expected sales are $7,500 of wood toys, $2,500 of metal toys, and $3,500 of plastic toys. What is the value of the complementary effect of the plastic toys? $3,000 Rationale: Complementary effect = ($7,500 - $5,000) + ($2,500 - $2,000) = $3,000 Which of these illustrates a complementary effect? Select all that apply. A new product increases traffic flow thereby increasing the revenue generated by a firm's existing products A new product increases the sales of one of the firm's existing products How is a complementary effect defined? Any increase in the current level of sales, costs, or necessary assets of a firm's existing operations caused by a new project

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How are the dividends paid on stock included in the analysis of a new project? Financing costs, such as dividends, are considered in the component costs of capital when a project's WACC is calculated. What is a financing cost? Interest and dividends paid as a result of external financing Why are financing costs excluded from project cash flows? Financing costs are included in the required return used to discount project cash flows. Which of these is the best description of the substitution effect? Any decrease in the level of sales, costs, or necessary assets of a firm's current operations that is caused by the implementation of a new project How is bond interest included in the analysis of a new project? Bond interest is included in the computation of a bond's yield to maturity, which is the pretax cost of debt used to compute a project's WACC Which of these are financing costs? Select all that apply. Bond interest Stock dividend

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True or false: Since financing costs are included in project WACC, which are used to discount project cash flows, we need to count them as expenses on the project False Free cash flows for which one of the following are affected by estimation error? Project free cash flows only McGinty's purchased a new machine for $318,000, paid $19,000 in sales tax, and $7,500 in delivery charges. The firm paid $3,400 to have the machine calibrated once it was set in place. The machine requires $5,600 of annual maintenance. What is the depreciable basis of the machine? $347,900 Rationale: Depreciable basis = $318,000 + $19,000 + $7,500 + $3,400 = $347,900 What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Firm free cash flows are actual values while project free cash flows are estimates. How can straight-line depreciation be defined? Ignore the half-year convention. Total amount to be depreciated spread evenly over an asset's life Ty's purchased a machine costing $11,000 and paid $660 in sales tax. Shipping and installation cost $1,500. The machine has a 3-year life after which it should have a book value of $3,500 and a market value of $5,000. What is the annual, straight-line depreciation, ignoring the half year convention? $3,220

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Rationale: Depreciation = ($11,000 + $660 + $1,500 - $3,500)/3 = $3,220 What types of costs are included in an asset's depreciable basis? Select all that apply. Purchase price of the asset Sales tax and freight charges Installation and testing costs A firm purchased a new machine costing $28,000 including sales tax. It also paid $2,000 for delivery and installation. The machine has a life of 6 years and an expected ending book value of $5,000. How is the depreciation computed using the straight-line method? Ignore the half-year convention. ($28,000 + $2,000 - $5,000)/6 Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention. (Depreciable basis - Ending book value)/Life of asset The Foster House purchased a machine costing $10,000 and paid $600 in sales tax. Shipping and installation cost $1,400. The machine has a 5-year life after which it should have a book value of $5,000 and a market value of $4,000. What is the annual, straight-line depreciation, ignoring the half year convention? $1,600 Rationale: Depreciation = ($10,000 + $600 + $1,400 - $5,000)/5 = $1,400

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Which one of these is a correct formula for OCF, assuming there is no interest expense? Net income + Depreciation Rationale: OCF = Net income + Depreciation A new asset costs $28,000 including all sales taxes and other installation costs. The asset is to be depreciated to an ending book value of $5,000 over the asset's 5-year life. The asset is expected to be sold for $7,800 at the end of the five years. How is the annual depreciation computed? ($28,000 - $5,000)/5 The values for the first year of a project are: Expected sales of 280 units, a selling price of $46, fixed costs of $3,100, depreciation of $1,100, variable cost per unit of $28, and a tax rate of 35 percent. What is the OCF? $1,646 Rationale: OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646 Suppose a project has an EBIT of -$1,500. If the tax rate is 21%, what are the computed taxes? Negative $315 Manor's purchases some equipment in preparation for a new project. Which of these are time zero cash flows for that project? Select all that apply. Purchase price of the equipment Shipping costs to have the equipment delivered

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Installation and initial testing costs What types of activities related to a project's fixed assets can create a cash flow for the final year of a project? Select all that apply. Selling the project's equipment Scrapping equipment that has a positive book value but no market value Trading in the project's equipment on new equipment for other projects How is operating cash flow (OCF) defined? EBIT (1 - Tax rate) + Depreciation Values for the first year of a project are projected as: Sales = $1,800, Depreciation = $300, Fixed costs = $450, Variable costs = $620, Tax rate = 34 percent. What is the OCF? $583.80 Rationale: OCF = ($1,800 - $620 - $450 - $300)(1 - 0.34) + $300 = $583.30 How are taxes computed when a project's EBIT is negative? The tax rate is multiplied by EBIT producing a tax credit. Which one of these represents a time zero project cash flow?

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Purchase of new equipment to start a project What two conditions must exist for equipment to have no effect on a project's final cash flows? Select two. Assume there are no disposal costs. Zero book value Zero market value Which one of these explains the after-tax cash flow formula for the sale of an asset? The cash flow equals the book value plus the after-tax value of any gain or loss on the sale. Rationale: ATCF = Book value + (Market value - Book value)(1 - TC). In four years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35 percent. What is the free cash flow for year 4? $13,100 Rationale: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185; FCF = $7,185 + $13,300(1 - 0.35) - $4,200(1 - 0.35) = $13,100 A firm purchased equipment at a total cost of $287,000, which was depreciated straight-line over seven years. After five years, the equipment was sold for $98,900. What is the ATCF at a tax rate of 34 percent? $93,154

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Rationale: Book value = $287,000 - (5/7 × $287,000) = $82,000; ATCF = $82,000 + ($98,900 - $82,000)(1 - 0.34) = $93,154 If you add all the cash flows related to net working capital (NWC) over a project's life, what sum must you obtain if your cash flows are correct? Zero How is the gain or loss on a sale of equipment determined? Market value - Book value A project has projected annual sales of $96,000, $112,000 and $136,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 6 percent of the following year's sales. Which of these are correct cash flows for this project? Cash outflow of $1,440 in year 2. Rationale: Year 2 cash outflow = 0.06 × ($136,000 - $112,000) = $1,440 In 4 years, an existing machine will have a zero book value and a market value of $4,200. A new machine costing $26,400 can replace this machine, lower variable costs by $8,200 a year, and have a market value of $13,300 and a zero book value in 4 years. The incremental depreciation is $5,300. The tax rate is 35%. What is the operating cash flow for year 4? $7,185 Rationale: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185

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A firm purchased equipment at a total cost of $300,000, which was depreciated straight-line over six years. After six years, the equipment was sold for $100,000. What is the ATCF at a tax rate of 21%? $79,000 Rationale: Book value = $300,000 - (6/6 × $300,000) = $0; ATCF = $0 + ($100,000 - $0)(1 - 0.21) = $79,000 A project has a 3-year life and annual sales projections of $120,000, $160,000 and $190,000 for years 1 to 3, respectively. The project requires net working capital (NWC) equal to 5 percent of the next year's sales. How is this requirement handled in project analysis? Select all that apply. A cash outflow of [0.05 × ($160,000 - $120,000)] is recorded in year 1. A cash inflow of (0.05 × $190,000) occurs in year 3. A cash outflow of (0.05 × $120,000) is recorded at time zero. A project requires $21,000 of net working capital (NWC) over its 4-year life. Which one of these is correct? There is no cash flow for NWC in years 1 to 3. Rationale: There is a $21,000 outflow at time zero and a $21,000 inflow in year 4. A project requires $15,000 of net working capital throughout its 5-year life. How is this requirement handled in project analysis? Select all that apply. $15,000 is a cash inflow in year 5. $15,000 is a cash outflow at time zero.

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A project has a 3-year life and requires equipment costing $34,000. The OCF is estimated at $16,000 annually. NWC of $3,500 is required over the project's life. What cash flows occur at time zero? Select all that apply. -$3,500 -$34,000 A project has a 3-year life, net income of $10,000 a year, and a tax rate of 21%. The project requires $9,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $3,000 at the end of year 3. The NWC requirement is $1,500 which is returned at the end of year 3. What is the total cash flow for year 3? $16,871 Rationale: OCF = $10,000 + ($9,000/3) = $13,000; Book value at the end of year 3 = $0 ATCF = $0 + ($3,000 - $0)(1 - 0.21) = $2,371 Year 2 cash flow = $13,000 + $1,500 + $2,371 = $16,871 Over how many tax years will a 3-year asset be depreciated given the half-year convention? 4 years Rationale: Given the half-year convention, a 3-year asset will be depreciated over 4 years. A new project requires $24,000 of equipment which will be depreciated straight-line to zero over the project's 4-year life. The project requires $2,400 of NWC, the annual OCF is $16,000, and the tax rate is 35 percent. The equipment's market value at the end of year 4 is $5,000. What cash flows occur in year 4? Select all that apply. $5,000 × (1 - 0.35)

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$2,400 An asset has a 3-year life and a depreciable basis of $16,400. What is the depreciation in year 4 given straight-line depreciation with half-year convention. The depreciation table percentages are 16.67, 33.33, 33.33, and 16.67 percent for years 1 to 4, respectively. $2,733.88 Rationale: Depreciation Year 4 = 0.1667 × $16,400 = $2,733.88 A project has a 2-year life, net income of $14,500 a year, and a tax rate of 34 percent. The project requires $6,000 of equipment which will be depreciated straight-line over 3 years, and have a market value of $2,500 at the end of year 2. The NWC requirement is $1,500. What is the total cash flow for year 2? $20,330 Rationale: OCF = $14,500 + ($6,000/3) = $16,500; Book value at the end of year 2 = $6,000/3 = $2,000; ATCF = $2,000 + ($2,500 - $2,000)(1 - 0.34) = $2,330; Year 2 cash flow = $16,500 + $1,500 + $2,330 = $20,330 The half-year convention is based on which of these assumptions? All assets placed in service during a given period were placed in service at the mid-point of the period. An asset has a 4-year life and a depreciable basis of $12,000. What is the first year's depreciation given the straight-line method with half-year convention? The depreciation table percentages are 12.5, 25, 25, 25, and 12.5 for years 1 through 5, respectively. $1,500 Rationale:

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Depreciation Year 1 = 0.125 × $12,000 = $1,500 What does accelerated depreciation indicate? Depreciation in the first half of an asset's life is greater than half of the assets value. Why would a firm prefer to use MACRS rather than straight-line depreciation for tax purposes? The tax deduction from depreciation is greater in the early years. Rationale: The greater the depreciation, the lower the taxes. An asset cost $52,000, has a 5-year MACRS life, and a current book value of $41,600. The MACRS percentages for years 1 to 6 are 20, 32, 19.2, 11.52, 11.52, and 5.76 percent, respectively. What is the depreciation for year 2? $16,640 Rationale: Depreciation Year 2 = 0.32 × $52,000 = $16,640 Which one of these represents a limit placed on Section 179 deductions? Taxable income from the active conduct of the firm What is the double-declining balance (DDB) method of depreciation? The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value.

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Which one of these is a feature of MACRS depreciation? Depreciation commences with an accelerated method and later switches to a straight-line method. Which one of these is property eligible for a Section 179 deduction? A cow barn that you build on your farm Rationale: This is a single-purpose agricultural structure, which is eligible. An asset has an initial cost of $43,000 and is classified as 3- year MACRS property. The MACRS percentages are 33.33, 44.45, 14.81, and 7.41 percent for years 1 through 4, respectively. What is the depreciation for year 3? $6,368.30 Rationale: Depreciation Year 3 = 0.1481 × $43,000 = $6,368.30 How do Section 179 deductions aid small businesses? Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase. Which of these are properties eligible for a Section 179 deduction? Select all that apply. Machinery purchased by a firm Most storage facilities built by a firm

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An asset has a depreciable basis of $13,200 and qualifies as 3-year MACRS property. The MACRS percentages are: 16.67, 33.33, 33.33. and 16.67 percent for years 1 to 4, respectively. What is the year 3 ending book value? $2,200.44 Rationale: Book value3 = $13,200 × (1 - 0.1667 - 0.3333 - 0.3333) = $2,200.44 According to the time value of money, what increases if an asset it depreciated as quickly as possible? Present Value of the Income Tax Shield Which of these correctly apply to MACRS depreciation? Select all that apply. MACRS tables are provided by the IRS. MACRS uses DDB for 3- to 10-year property and then switches to SL when SL produces a higher depreciation value. All of the MACRS percentages found in the IRS tables are applied to an asset's initial depreciable basis. An asset is 5-year MACRS property and has an initial cost of $64,200. The MACRS percentages are: 20, 32, 19.2, 11.52, 11.52, and 5.76 percent for years 1 to 6, respectively. What is the book value at the end of year 4? $11,093.76

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Rationale: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76 Which of these are cash flows that apply to a replacement problem? Select all that apply. Cost of new asset Depreciation lost if existing asset is sold ATCF of an existing asset at its normal life-end Assume a firm has a tax rate of 34 percent which remains stable from year to year. Which type of depreciation should the firm use when computing its taxes? MACRS with half-year convention A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 4? $3,080 Rationale: The existing asset will be fully depreciated in year 3 so there is no foregone depreciation in year 4. Depreciation4 = $15,400/5 = $3,080 An asset with a remaining book value of $138 is sold for $96. How is the after-tax cash flow (ATCF) computed if the tax rate is 35 percent?

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ATCF = $138 + ($96 - $138)(1 - 0.35) A new machine will cost $820,000 and will replace an existing machine. The new machine will reduce variable costs by $170,000 per year. The incremental depreciation is $38,000 and the tax rate is 34 percent. What is the year 2 OCF? $125,120 Rationale: EBIT = $170,000 - $38,000 = $132,000; OCF = $132,000(1 - 0.34) + $38,000 = $125,120 How can a replacement problem be defined? Buying a new asset which will be used in place of an existing asset that is still usable A firm has an existing asset with a book value of $6,600 and annual depreciation of $2,200. Assume this asset is replaced with a new asset costing $15,400. The new asset will be depreciated straight-line over its 5-year life. What is the incremental depreciation for year 2? $880 Rationale: Depreciation2 = ($15,400/5) - $2,200 = $880 New equipment was purchased for a project at a total cost of $210,000 and was depreciated straight-line over five years. The equipment was sold at the end of three years for $68,000. How is the ATCF computed using a tax rate of 34 percent? Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) Rationale: Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34)

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A machine costing $79,000 will replace an old machine and lower annual variable costs by $15,500 over its 5-year life. The new machine will be depreciated using MACRS with rates of 33.33, 44.45, 14.81, and 7.41 percent for years 1 to 4, respectively. The old machine has a current book value of $39,600 and depreciation of $13,200. What is the incremental depreciation for year 3? -$1,500.10 Rationale: Incremental depreciation3 = ($79,000 × 0.1481) - $13,200 = -$1,500.10 A cost-cutting project is least apt to affect which one of these? Revenue Which one of these is a key assumption in situations where EAC is used as the decision method? Whenever the chosen asset wears out, it will be replaced with an identical asset. In essence, the EAC process makes a decision based on which one of these? Perpetuity payment amount What typifies a cost-cutting project? No revenue is generated by the project. Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply. Two assets can be used for the same purpose Both assets may produce the same level of sales.

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What is the first step in the EAC process? Find the sum of the present values of the cash flows for one iteration of each project Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable? Which asset will produce the least negative EAC? A machine has an initial cost of $32,000 and annual after-tax net expenses of $2,600. The life of the machine is three years, after which the machine will be worthless. The discount rate is 13 percent. How is the sum of the present values (NPV) of the machine's cash flows calculated? NPV = -$32,000 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133 Rationale: NPV = -$32,000 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133 You are comparing Machine A with a 3-year life and an EAC of -$21,407 and Machine B with a 4- year life and an EAC of -$22,013, Which machine, if either, should be accepted according to the EAC decision criteria? Accept Machine A What is the second step of the EAC process? Find the annuity payment that has the same present value as the sum of the present values of a project's cash flows

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A new asset costs $47,000, has a 3-year life, and annual after-tax net expenses of $3,700. What is the EAC at a discount rate of 11 percent? -$22,933.01 Rationale: NPV = -$47,000 - $3,700/1.11 - $3,700/1.112 - $3,700/1.113 = -$56,041.74; N = 3, I = 11, PV = 56,041.74, FV = 0, CPT PMT; PMT = -22,933.01 An asset has a 4-year life and a sum of present values (NPV) of cash flows of -$46,900. The discount rate is 12 percent. How is the equivalent annuity payment, or EAC, computed? N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT Rationale: The PV can be input as either a positive or a negative value when computing the payment. However, the actual payment amount must be negative since the NPV is negative. You are comparing Machine C with a 7-year life and an EAC of -$20,050 and Machine D with a 2- year life and an EAC of -$22,00 Which machine, if either, should be accepted according to the EAC decision criteria? Accept Machine A Rationale: Machine A has the less negative EAC and should be accepted. Why are a firm's target capital structure values used in computing the average flotation cost? The firm will issue securities in these percentages over the long term. A machine costs $112,000, has a 2-year life and annual after-tax net expenses of $31,400. What is the EAC at rate of 14 percent? -$99,416.45

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Rationale: NPV = -$112,000 - $31,400/1.14 - $31,400/1.142 = -$163,705.14; N = 2, I = 14, PV = 163,705.14, FV = 0, CPT PMT; PMT = -99,416.45 A firm has a target capital structure of 60 percent equity and 40 percent debt. The flotation cost of equity is 13 percent while it is 9 percent for debt. The initial cost of a project is $468,000. What is the flotation-adjusted cash flow for time zero? $528,217 Rationale: fA = (0.6 × 0.13) + (0.4 × 0.09) = 0.114 Adjusted CF0 = $468,000/(1 - 0.114) = $528,217 What is the first step in the process of adjusting the initial investment for flotation costs? Compute the weighted average flotation cost using the target capital weights Which of these correctly define free cash flow? Select all that apply. FCF = OCF - Investment in operating capital FCF = [EBIT(1 - Tax rate) + Depreciation] - [Change in gross fixed assets + Change in net operating working capital] A firm has a target capital structure of 50 percent equity, 10 percent preferred, and 40 percent debt. Their respective flotation costs are 12 percent, 10 percent, and 7 percent. What is the weighted average flotation cost? 9.80 percent Rationale: fA = (0.5 × 0.12) + (0.1 × 0.10) + (0.4 × 0.07) = 0.0980 = 9.80%

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Assume the initial costs of a project, CF0, are $38,000 and the weighted average flotation cost, fA, is 6.7 percent. How is the flotation-adjusted CF0 computed? $38,000/(1 - 0.067) How is free cash flow defined? Cash flow available for distribution to a firm's investors

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BUS 350 Principles of finace Chapter 12 smartbook

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