Ch 7 Exercise new with solutions

1. The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's:
A. i ncremental cash flows.
B. i nternal cash flows.
C. e xternal cash flows.
D. e rosion effects.
E. f inancing cash flows.
2. Which of the following should be included in the analysis of a new product?
I. money already spent for research and development of the new product
II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product
A. I and III only
B. I I and IV only
C. I, II, and III only
D. I I, III, and IV only
E. I, II, III, and IV
3. The depreciation tax shield is best defined as the:
A. a mount of tax that is saved when an asset is purchased.
B. t ax that is avoided when an asset is sold as salvage.
C. a mount of tax that is due when an asset is sold.
D. a mount of tax that is saved because of the depreciation expense.
E. a mount by which the aftertax depreciation expense lowers net income.
4. All of the following are related to a proposed project. Which of these should be included in the cash flow at time zero?
I. purchase of $1,400 of parts inventory needed to support the project
II. loan of $125,000 used to finance the project
III. depreciation tax shield of $1,100
IV. $6,500 of equipment needed to commence the project
A. I and II only
B. I and IV only
C. I I and IV only
D. I, II, and IV only
E. I, II, III, and IV
5. You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine which has the:
A. l ongest life.
B. h ighest annual operating cost.
C. l owest annual operating cost.
D. h ighest equivalent annual cost.
E. l owest equivalent annual cost.
6. Changes in the net working capital requirements:
A. c an affect the cash flows of a project every year of the project's life.
B. o nly affect the initial cash flows of a project.
C. o nly affect the cash flow at time zero and the final year of a project.
D. a re generally excluded from project analysis due to their irrelevance to the
total project.
E. r eflect only the changes in the current asset accounts.
7. Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero?
A. E BIT + D
B. E BIT - T
C. N I + D
D. (Sales - Costs) × (1 - D) × (1- T)
E. (Sales - Costs) × (1 - T)
8. Jefferson & Sons is evaluating a project that will increase annual sales by $145,000 and annual cash costs by $94,000. The project will initially require $110,000 in fixed assets that will be depreciated straight-line to a zero book value over the 4-year life of the project. The applicable tax rate is 32 percent. What is the operating cash flow for this project?
A. $11,220
B. $29,920
C. $43,480
D. $46,480
E. $46,620
OCF = ($145,000 - $94,000)(1 - 0.32) + ($110,000/4)(0.32) = $43,480
9. The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $238,000 and cash expenses by $184,000. The initial investment will require $96,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 32 percent. What is the annual value of the depreciation tax shield?
A. $5,120
B. $13,160
C. $25,840
D. $32,560
E. $41,840
Depreciation tax shield = ($96,000/6) × 0.32 = $5,120
10. Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $28,200, and a 4-year life. Machine B costs $1,118,000, has annual operating costs of $19,500, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Precision Tool should purchase Machine _____ because it lowers the firm's annual cost by approximately _______ as compared to the other machine.
A. A; $12,380
B. A; $17,404
C. B; $16,965
D. B; $17,404
E. B; $17,521
Difference in costs = -$340,636.69 - (-$353,016.79) = $12,380.09
11. The Buck Store is considering a project that will require additional inventory of $216,000 and will increase accounts payable by $181,000. Accounts receivable are currently $525,000 and are expected to increase by 9 percent if this project is accepted. What is the project's initial cash flow for net working capital?
A. -$82,250
B. -$12,250
C. $12,250
D. $36,250
E. $44,250
NWC requirement = -$216,000 + $181,000 - ($525,000 × 0.09) = - $82,250
12. Can the initial cash flow at time zero for a project ever be a positive value? If yes, give an example. If no, explain why not.
The initial cash flow can be a positive value. For example, if a project reduced net working capital by an amount that exceeded the initial cost for fixed assets, the initial cash flow would be a positive amount.
13. What is the formula for the tax-shield approach to OCF? Explain the two key points the formula illustrates.
OCF = (Sales - Costs) × (1 - T) + Depreciation × T
The formula illustrates that cash income and expenses affect OCF on an aftertax basis.
The formula also illustrates that even though depreciation is a non-cash expense it does affect OCF because of the tax savings realized from the depreciation expense.
14. What is the primary purpose of computing the equivalent annual costs when comparing two machines? What is the assumption that is being made about each machine?
The primary purpose is to compute the annual cost of each machine on a comparable basis so that the least expensive machine can be identified given that the machines generally have differing lives and costs. The assumption is that whichever machine is acquired, it will be replaced at the end of its useful life.
15. If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:
A.i ndependent.
B. i nterdependent.
C. m utually exclusive.
D. e conomically scaled.
E. o perationally distinct.
16. Which one of the following methods determines the amount of the change
a proposed project will have on the value of a firm?
A.n et present value
B. d iscounted payback
C. i nternal rate of return
D. p rofitability index
E. p ayback
17. If a project has a net present value equal to zero, then:
A.t he total of the cash inflows must equal the initial cost of the project.
B. t he project earns a return exactly equal to the discount rate.
C. a decrease in the project's initial cost will cause the project to have a
negative NPV.
D. a ny delay in receiving the projected cash inflows will cause the project to
have a positive NPV.
E. t he project's PI must be also be equal to zero.
18. Why is payback often used as the sole method of analyzing a proposed small project?
A.P ayback considers the time value of money.
B. A ll relevant cash flows are included in the payback analysis.
C. I t is the only method where the benefits of the analysis outweigh the costs
of that analysis.
D. P ayback is the most desirable of the various financial methods of analysis.
E. P ayback is focused on the long-term impact of a project.
19. Which of the following are considered weaknesses in the average accounting return method of project analysis?
I. exclusion of time value of money considerations
II. need of a cutoff rate
III. easily obtainable information for computation
IV. based on accounting values
A.I only
B. I and IV only
C. I I and III only
D. I, II, and IV only
E. I, II, III, and IV
20. Which one of the following statements related to the internal rate of return (IRR) is correct?
A.T he IRR yields the same accept and reject decisions as the net present
value method given mutually exclusive projects.
B.A project with an IRR equal to the required return would reduce the value of
a firm if accepted.
C. T he IRR is equal to the required return when the net present value is equal
to zero.
D. F inancing type projects should be accepted if the IRR exceeds the required
return.
E. T he average accounting return is a better method of analysis than the IRR
from a financial point of view.
21. Douglass Interiors is considering two mutually exclusive projects and have determined that the crossover rate for these projects is 11.7 percent. Project A has an internal rate of return (IRR) of 15.3 percent and Project B has an IRR of 16.5 percent. Given this information, which one of the following statements is correct?
A.P roject A should be accepted as its IRR is closer to the crossover point than
is Project B's IRR.
B. P roject B should be accepted as it has the higher IRR.
C. B oth projects should be accepted as both of the project's IRRs exceed the
crossover rate.
D. N either project should be accepted since both of the project's IRRs exceed
the crossover rate.
E. Y ou cannot determine which project should be accepted given the
information provided.
22. Which one of the following methods of analysis provides the best information on the cost-benefit aspects of a project?
A.n et present value
B. p ayback
C. i nternal rate of return
D. a verage accounting return
E. p rofitability index
23. When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:
A.a ccepted because the internal rate of return is positive.
B. a ccepted because the profitability index is greater than 1.
C. a ccepted because the profitability index is negative.
D. r ejected because the internal rate of return is negative.
E. r ejected because the net present value is negative.
24. Southern Chicken is considering two projects. Project A consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project B would use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods?
A.p rofitability index
B. i nternal rate of return
C. p ayback
D.n et present value
E. a ccounting rate of return
25. Which of the following are definite indicators of an accept decision for an independent project with conventional cash flows?
I. positive net present value
II. profitability index greater than zero
III. internal rate of return greater than the required rate
IV. positive internal rate of return
A.I and III only
B. I I and IV only
C. I, II, and III only
D. I I, III, and IV only
E. I, II, III, and IV
26. Explain the differences and similarities between net present value (NPV) and the profitability index.
A：The NPV and PI both consider the time value of money and result in the same accept or reject decision when considering an independent project. The main difference between the two is that the PI may be useful in determining which projects to accept if funds are limited; however, the PI may lead to incorrect decisions when considering mutually exclusive investments.
27. The profitability index (PI) of a project is 1.0. What do you know about the project's net present value (NPV) and its internal rate of return (IRR)?
If the PI is equal to 1.0, then the NPV = 0 and the IRR = Required return.
28. How does the net present value (NPV) decision rule relate to the primary goal of financial management, which is creating wealth for shareholders?
A: The NPV rule states that a project should be accepted if the NPV is positive and rejected if the NPV is negative. This aligns with the goal of creating wealth for a firm's shareholders as only projects which create wealth are approved for acceptance. Managers are indifferent to projects with zero NPVs, which is okay because such projects neither create nor destroy shareholder wealth.。