Chapter 09 - Making Capital Investment Decisions
95. The Golf Range is considering adding an additional driving range to its facility. The range would cost $76,000, would be depreciated on a straight line basis over its 7-year life, and would have a zero salvage value. The anticipated income from the project is $34,000 a year with $14,400 of that amount being variable cost. The fixed cost would be $16,200. The firm believes that it will earn an additional $13,000 a year from its current operations should the driving range be added. The project will require $2,000 of net working capital, which is recoverable at the end of the project. What is the internal rate of return on this project at a tax rate of 34 percent? A. 7.53 percent B. 9.29 percent C. 11.47 percent D. 12.68 percent E. 14.04 percent
96. A project has an initial requirement of $698,700 for fixed assets and $61,000 for net
working capital. The fixed assets will be depreciated to a zero book value over the 4-year life of the project and will be worthless at the end of the project. All of the net working capital will be recouped after 4 years. The expected annual operating cash flow is $218,000. What is the project's internal rate of return if the tax rate is 35 percent? A. 7.72 percent B. 8.41 percent C. 8.69 percent D. 9.11 percent E. 9.97 percent
Essay Questions
97. Explain the concept of incremental cash flow analysis and its purpose.
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Chapter 09 - Making Capital Investment Decisions
98. Explain the difference between scenario analysis and sensitivity analysis and identify the purpose of each.
99. Explain the difference between a sunk cost and an opportunity cost and give an example of each.
100. Explain how the selection of a method of depreciation can affect the net present value of an investment for a tax-paying firm.
101. Identify three managerial options that relate to project analysis and explain how those options affect the net present value of a project.
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Multiple Choice Questions
102. Travel Coaches currently sells 14,000 motor homes per year at $94,000 each, and 1,500 luxury motor coaches per year at $159,000 each. The company wants to introduce a low-range camper to fill out its product line; it hopes to sell 6,000 of these campers per year at $14,500 each. An independent consultant has determined that if Travel Coaches introduces the new campers, it should boost the sales of its existing motor homes by 1,100 units per year, and reduce the sales of its luxury motor coaches by 450 units per year. What amount should be used as the annual sales figure when evaluating this project? A. $87,000,000 B. $97,400,000 C. $118,850,000 D. $186,750,000 E. $261,950,000
103. Consider an asset that costs $459,000 and is depreciated straight-line to zero over its
6-year tax life. The asset is to be used in a 4-year project; at the end of the project, the asset can be sold for $120,000. If the relevant tax rate is 34 percent, what is the aftertax cash flow from the sale of this asset? A. $131,220 B. $127,840 C. $116,500 D. $97,600 E. $79,200
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Chapter 09 - Making Capital Investment Decisions
104. An asset used in a 3-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $5.4 million and will be sold for $1.2 million at the end of the project. If the tax rate is 35 percent, what is the aftertax salvage value of the asset?
Table 9.7 Modified ACRS depreciation allowances A. $1,075,680 B. $780,000 C. $904,320 D. $1,324,320 E. $1,187,560
105. Miller's, Inc. is considering a new 4-year expansion project that requires an initial fixed asset investment of $3.6 million. The fixed asset will be depreciated straight-line to zero over its 4-year life, after which time it will be worthless. The project is estimated to generate $3.9 million in annual sales, with costs of $2.6 million. If the tax rate is 34 percent, what is the OCF for this project? A. $1,164,000 B. $997,720 C. $684,280 D. $858,000 E. $911,760
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Chapter 09 - Making Capital Investment Decisions
106. The Sausage Hut is looking at a new sausage system with an installed cost of $438,000. This cost will be depreciated straight-line to zero over the project's 4-year life, at the end of which the sausage system can be scrapped for $69,000. The sausage system will save the firm $129,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $29,000, which will be recouped at project end. If the tax rate is 35 percent and the discount rate is 9 percent, what is the NPV of this project? A. -$18,870 B. -$6,320 C. $2,560 D. $14,410 E. $26,880
107. Your firm is contemplating the purchase of a new $674,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 6-year life. It will be worth $58,000 at that time. You will save $185,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $29,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 34 percent, what is the IRR for this project? A. 12.51 percent B. 12.79 percent C. 13.01 percent D. 13.53 percent E. 14.20 percent
108. Industrial Machines has the following estimates for its new gear assembly project: price = $1,340 per unit; variable costs = $348 per unit; fixed costs = $5.1 million; quantity = 82,000 units. Suppose the company believes all of its estimates are accurate only to within ? 4 percent. What value should the company use for its total variable costs when performing its best-case scenario analysis? A. $26,578,064 B. $28,490,342 C. $28,536,000 D. $29,802,130 E. $30,864,538
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