Chapter 14 MC

Question 1

1) Which of the following is NOT appropriate for estimating the cash flows associated with capital expenditure decisions?

a) Discount nominal cash flows with nominal discount rates, and real cash flows with real discount rates.
b) Include associated interest and dividend payments.
c) Use after-tax cash flows with an after-tax discount rate.
d) Use the marginal or incremental cash flows arising from capital budgeting decisions.

Answer 1

b

Question 2

2) Which of the following should NOT be considered in the capital budgeting decision?

a) Working capital requirements.
b) Initial cash outlay.
c) Opportunity costs.
d) Sunk costs.

Answer 2

d

Question 3

3) Which of the following should be accounted for in the capital budgeting decision?

a) Externalities.
b) Intangible considerations that cannot be measured.
c) Opportunity costs.
d) Sunk costs.

Answer 3

c

Question 4

4) Which of the following should be ignored in the capital budgeting decision?

a) The effect of all project interdependencies.
b) Social investments required by law.
c) Inflation.
d) Externalities.

Answer 4

d

Question 5

5) Incremental cash flows are of primary interest in capital budgeting decisions because:

a) They are more relevant than intangible costs and benefits.
b) They are able to correct for a portion of the uncertainty due to the long time horizon.
c) The change in the company’s future cash flows is what is being estimated.
d) They are the easiest cash flows to identify.

Answer 5

c

Question 6

6) Which of the following is NOT an incremental cash flow?

a) Research and development costs for the new product, which have already been undertaken.
b) Reduction in sales of an existing product line as a result of the introduction of the new product line.
c) Cannibalization
d) Proceeds from the sale of old equipment.

Answer 6

a

Question 7

7) A firm is considering a project that has cash flows indexed to the consumer price index.What discount rate should be chosen?

a) Nominal discount rate
b) Yield to maturity
c) Change in consumer price index
d) A rate that uses the consumer price index in its measure

Answer 7

d

Question 8

8) Which of the following is NOT an example of cannibalization?

a) Kellogg’s introduces a new type of cereal.
b) Ford rolls out a new model of car.
c) Molson brings out a new beer.
d) Canadian Tire allows Tim Horton’s to operate a concession stand in their retail outlets.

Answer 8

d

Question 9

9) Use the following statements to answer this question:
I. When we are dealing with cannibalization of a project, we should ignore the old product.
II. Increases in incremental cash flows can be gained from decreases in expenses.

a) I and II are correct
b) I and II are incorrect
c) I is correct and II is incorrect
d) I is incorrect and II is correct

Answer 9

d

Question 10

10) A Canadian oil company is considering whether or not to develop a site it has been exploring for the past six months. One of the arguments for developing the site is that considerable time and money have already been expended. This cost should not be included in the capital budgeting decision because it is:

a) an opportunity cost.
b) a sunk cost.
c) an operating cost
d) a financing cost

Answer 10

b

Question 11

11) A company is considering taking over a firm that has a very good company image. The company image cannot be assessed in financial terms and has no direct link to the change in cash flows. How can we categorize the company’s image?

a) Opportunity cost
b) Sunk Cost
c) Externality
d) Intangible

Answer 11

d

Question 12

12) A real estate company started the exploration of buying a piece of land for condos. The company bought the land and started breaking ground. The housing market crashed, and the amount spent may not be recovered completely. What do we call the costs involved with the development of the land?

a) An opportunity cost.
b) A sunk cost.
c) An incremental cost
d) A financing cost

Answer 12

b

Question 13

13) A real estate company started the exploration of buying a piece of land for condos. The company bought the land and started breaking ground. The housing market crashed, and the amount spent may not be recovered completely. What do we call the costs involved with the purchase of the land?

a) An opportunity cost.
b) A sunk cost.
c) An incremental cost
d) A financing cost

Answer 13

a

Question 14

14) A pharmaceutical company has discovered a new drug that treats gastrointestinal disorders. In the testing phase of this new drug, the company further discovered that the drug is effective against migraine headaches. The R&D costs for the drug were $3 million. When evaluating the capital budgeting decision for the migraine remedy, what portion of the R&D costs for the drug should be attributed to the migraine budget?

a) 0 percent of the R&D costs.
b) 50 percent of the R&D costs.
c) 100 percent of the R&D costs.
d) It cannot be determined until the drug is further tested. There may be more uses for this drug and further testing is required.

Answer 14

a

Question 15

15) A pharmaceutical company has discovered a new drug that treats gastrointestinal disorders. The R&D costs for the drug were $3 million. In the testing phase of this new drug, the company further discovered that there is a possibility that the drug would be effective against migraine headaches if they invest another 10% in R&D. When evaluating the capital budgeting decision for the migraine remedy, what portion of the R&D costs for the drug should be attributed to the migraine budget?

a) 0 percent of the R&D costs.
b) $ 300,000 of the R&D costs.
c) $ 1.65 million of the R&D costs.
d) It cannot be determined until the drug is further tested. There may be more uses for this drug and further testing is required.

Answer 15

b

Question 16

16) Which of the following would NOT be included in a capital budgeting evaluation?

a) Incremental cash flows
b) External benefits
c) Effects of price level changes
d) Taxes

Answer 16

b

Question 17

17) Which of the following would be considered relevant cash flows in a capital budgeting evaluation?
I. Increased after-tax income.
II. Tax savings due to increased depreciation expense.
III. Increased expenditures on inventory for the new project.
IV. Benefits that accrue to the local community.

a) I, II, and III.
b) I, II, and IV.
c) I, III, and IV.
d) I, II, III, and IV.

Answer 17

a

Question 18

18) Which of the following is NOT relevant to the cash flow estimates that are associated with a project?

a) The associated financing costs.
b) The economic life of the project.
c) The effect of inflation.
d) The terminal cash flow.

Answer 18

a

Question 19

19) Use the following two statements to answer this question:
I. The initial after-tax cash flow refers to the total cash outlay that is required to initiate an investment project and can be depreciated for tax purposes.
II. The capital cost of an investment refers to all costs incurred to make an investment operational, which includes the additional working capital requirements.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 19

b

Question 20

20) Which of the following is correct with respect to working capital and capital budgeting?

a) Working capital is ignored in the capital budget.
b) Working capital has a different discount rate.
c) Working capital is assumed to be recuperated at the end of the life of the project.
d) Working capital does not affect cash flow.

Answer 20

c

Question 21

21) If the asset is depreciated completely before the end of the life of the project, what happens to the salvage value?

a) The salvage value is ignored in the capital budget.
b) The salvage value is amortized further.
c) The after-tax salvage value is discounted at the date of the disposal of the asset.
d) The asset’s life is extended.

Answer 21

c

Question 22

22) Which of the following is NOT a component of the initial after-tax cash flow?

a) The change in the net working capital requirements.
b) The initial capital cost of the asset.
c) The original cost of a capital asset that was incurred several years ago.
d) The opportunity costs associated with the project.

Answer 22

c

Question 23

23) According to Canada Revenue Agency:
I. The purchase cost of a capital asset is to be capitalized and its value expensed as depreciation expense over future periods.
II. The modification costs of a capital asset have to be expensed immediately.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 23

c

Question 24

24) What is the difference between the initial cash flow and the purchase price of an asset?

a) Set up costs only
b) Capital costs
c) Other capital costs and net working capital
d) None of the above

Answer 24

c

Question 25

25) Which of the following is NOT a component of the expected annual after-tax cash flows?

a) The additional depreciation expense that results from the capital cost of the investment.
b) The additional taxes paid that result from the capital budgeting decision.
c) The incremental increase in after-tax operating income of the project.
d) The incremental tax savings that result from the initial investment outlay.

Answer 25

a

Question 26

26) The following equation ((SV-C0)T)/〖(1+k)〗^t is:

a) Present value of the salvage value.
b) Present value of the terminal value of the asset.
c) Present value of the taxes owed on the gain resulting from the sale of an asset.
d) The present value of the depreciation.

Answer 26

c

Question 27

27) Because CCA is a non-cash expense, in estimating the annual after-tax cash flows, we have to deal with it using one of the following two approaches:
I. Deduct CCA from operating income, then deduct the associated taxes payable, and finally add the amount of the CCA tax savings back.
II. Multiply the CCA by the company’s effective tax rate and add this amount to the after-tax operating income.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 27

d

Question 28

28) Why do we add the present value of the CCA tax shield to the NPV?

a) Tax shield is a cost.
b) The CAA tax shield arises from amortizing the asset.
c) The CCA tax shield arises from expensing interest rates.
d) None of the above

Answer 28

b

Question 29

29) Use the following two statements to answer this question:
I. The use of declining balance CCA means that the tax deductions last forever and the asset is never fully depreciated.
II. The half-year rule results in CCA expense that is lower in year 1 and highest in year 2.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 29

a

Question 30

30) Which of the following is NOT a true statement?

a) A capital loss arises when the selling price of an asset is lower than the original purchase price.
b) A capital gain arises when the selling price of an asset is greater than the original capital cost.
c) CCA recapture occurs when the salvage value of an asset exceeds the UCC and selling the asset terminates the CCA asset class.
d) A terminal loss occurs when the salvage value of an asset is less than the ending UCC and selling the asset terminates the CCA asset class.

Answer 30

a

Question 31

31) Which of the following is most likely to occur upon termination of a project?

a) Capital gains
b) CCA recapture
c) Terminal losses
d) Working capital recapture

Answer 31

d

Question 32

32) Montreal Sun Printing is looking at an opportunity of setting up a new production facility, which requires the purchase of a new printing press that costs $1 million. The costs to install the machine are $60,000. The new facility is to be built on a piece of land that the company bought for $150,000 five years ago. The market value of the land is $250,000. The R&D costs associated with the investment opportunity were $50,000. In addition, the company will need to purchase $40,000 additional inventory for the project use. What is the initial after-tax cash flow associated with the investment opportunity?

a) $1,250,000
b) $1,300,000
c) $1,350,000
d) $1,400,000

Answer 32

Answer: c, CF0 = $1,000,000 + $60,000 + $40,000 + $250,000 = $1,350,000

Question 33

33) Montreal Sun Printing is looking at an opportunity of setting up a new production facility, which requires the purchase of a new printing press that costs $1 million. The costs to install the machine are $60,000. The new facility is to be built on a piece of land that the company bought for $150,000 five years ago. The market value of the land is $250,000. The R&D costs associated with the investment opportunity were $50,000. In addition, the company will need to purchase $40,000 additional inventory for the project use. How much of these costs can be categorized as a sunk cost?

a) $250,000
b) $60,000
c) $50,000
d) None of them

Answer 33

c

Question 34

34) La Montrealaise Transportation Company is considering a project, which requires the purchase of a fleet of trucks costing $500,000. It will need to spend $65,000 to modify the trucks before they can be put into operation. The associated opportunity costs are $35,000. In addition, the company will need to spend $10,000 on additional spare parts inventory. What is the capital cost associated with the investment opportunity?

a) $500,000
b) $565,000
c) $575,000
d) $610,000

Answer 34

b,

C0 = $500,000 + $65,000 = $565,000

Question 35

35) Given the following information on a project: initial capital cost = $500,000; installation costs associated with the capital asset = $25,000; R&D costs associated with the project = $50,000; associated opportunity costs = $80,000; increase in raw materials inventory = $10,000. What is the initial cash outlay of the project?

a) $535,000
b) $590,000
c) $615,000
d) $665,000

Answer 35

c,

CF0 = $500,000 + $25,000 + $10,000 + $80,000 = $615,000

Question 36

36) Given the following information on a project: initial capital cost = $500,000; installation costs associated with the capital asset = $25,000; R&D costs associated with the project = $50,000; associated opportunity costs = $80,000; increase in raw materials inventory = $10,000. Which of these amounts is included with working capital?

a) $ 500,000
b) $ 80,000
c) $ 10,000
d) $ 25,000

Answer 36

c

Question 37

37) La Poutine Cheese Products Inc. is considering a project that requires an initial cash outlay of $290,000, comprised of $235,000 for the purchase of new equipment, $13,000 for the installation costs, and $42,000 for additional inventory. In addition, the R&D associated with the project was $5,000 and its opportunity costs are $28,000. What is the capital cost associated with the investment opportunity?

a) $235,000
b) $248,000
c) $290,000
d) $318,000

Answer 37

b

C0 = $235,000 + $13,000 = $248,000

Question 38

38) Which one of the following represents the change in net working capital?

a) The level of inventory in the project.
b) The difference between the account receivables at the end and beginning of the project.
c) The difference between the account payables at the end and beginning of the project.
d) The difference between current assets and current liabilities.

Answer 38

d

Question 39

39) Unique Style Inc. is considering a five-year expansion project that requires an initial investment of $500,000 for the purchase of a new machine with a CCA rate of 30 percent. The projected sales revenue and related costs are $450,000 and $180,000 per year, respectively. The project’s fixed costs are an additional $48,000 per year. The appropriate discount rate is 8 percent. The firm’s marginal tax rate is 40 percent. What is the after-tax cash flow in year three?

a) $162,600
b) $168,900
c) $191,400
d) $197,700

Answer 39

Answer: b,
CCA3 = $500,000(1 – 30%/2)(1 – 30%)*30% = $89,250

CFAT3 = ($450,000 - $180,000 - $48,000)(1 – 40%) + $89,25040% = $168,900

Question 40

40) The following information was reported last year:

Beginning	Ending Accounts receivable	$85,250	$75,338 Accounts payable	$72,362	$55,124 Inventory	$51,225	$63,037

What was the effect of the change in net working capital on cash flow for the year?

a) –$19,138
b) –$15,338
c) $19,138
d) $15,338

Answer 40

a

– $(75,338– 85,250) + $(55,124 – 72,362) – $(63,037–51,225) = –$19,138

Question 41

41) The following information was reported last year:

Beginning	Ending Accounts receivable	$65,250	$75,338 Accounts payable	$42,362	$55,124 Inventory	$51,225	$51,225

What was the change in net working capital for the year?

a) $2,674
b) –$22,850
c) $-2,674
d) $–$22,850

Answer 41

a, Change in NWC = $(65,250 – 75,338) + $(55,124 – 42,362) + $0= $2,674

Question 42

42) Given the following information from last year’s financial statements:

Beginning	Ending Inventory	$80,233	$71,169 Accounts Receivable	$73,489	$64,508 Accounts Payable	$55,332	$42,256

What was the net cash flow if the reported sales revenue and costs for the same period were $582,366 and $437,265, respectively?

a) $113,980
b) $140,132
c) $150,070
d) $176,222

Answer 42

Answer: c, Change in NWC = $(80,233 – 71,169) + $(73,489 – 64,508) + $(42,256 – 55,332)
= $4,969. Net CF = $582,366 – $437,265 + $4,969 = $150,070

Question 43

43) Champlain Transportation Inc. is considering a five-year project that requires an initial capital investment of $1 million. The project is expected to generate operating revenue of $500,000 per year, and the associated operating expenses are estimated at $250,000 per year. The capital asset belongs to asset class 9, which has a CCA rate of 30 percent. The firm’s marginal tax rate is 35 percent. What is the after-tax cash flow for year 1?

a) $215,000
b) $267,500
c) $302,500
d) $312,500

Answer 43

Answer: a,
CCATS1 = $1,000,000(30%/2)35% = $52,500

CFAT1 = $(500,000 – 250,000)*(1 – 35%) + $52,500 = $215,000

Question 44

44) Champlain Transportation Inc. is considering a six-year project that requires $800,000 for the purchase of a capital asset with a CCA rate of 30 percent. The project is expected to generate sales revenue of $600,000 per year. The project’s variable and fixed costs are estimated at $240,000 and $50,000 per year, respectively. The firm’s marginal tax rate is 35 percent and cost of capital is 12 percent. What is the present value of the after-tax operating cash flows?

a) $828,449
b) $962,069
c) $1,274,536
d) $1,480,107

Answer 44

Answer: a,

PV(CFAT) = $(600,000 – 240,000 – 50,000)(1 – 35%)PVAF(12%,6) = $828,449

Question 45

45) Toronto Skates Corp. is considering a five-year project that requires an initial investment of $250,000. The project is expected to generate operating incomes of $60,000 in year 1, $90,000 in year 2, $150,000 in year 3, $100,000 in year 4, and $80,000 in year 5. The asset belongs to asset class 7, which has a CCA rate of 15 percent. The firm’s marginal tax rate is 35 percent and cost of capital is 10 percent. What is the present value of the after-tax operating cash flows?

a) $205,272
b) $233,739
c) $315,804
d) $359,598

Answer 45

Answer: b, CFAT = CFBT*(1 – 35%)
CFAT of years 1-5: $39,000
/1.10; $58,500/1.10 exp2; $97,500/1.10exp3; $65,000/1.10 exp4; $52,000/1.10 exp 5
= 233,738.63

Question 46

46) BC Travel Services is considering a new ten-year project that will generate additional sales revenue of $200,000 per year. The associated costs are $120,000 per year. The project is somewhat riskier than the company’s current operations, and hence requires a risk premium of 2 percent. The company’s cost of capital is 12 percent and marginal tax rate is 40 percent. What is the present value of the after-tax operating cash flows?

a) $250,374
b) $271,211
c) $417,289
d) $452,018

Answer 46

Answer: a, PV(CFAT) = $(200,000 – 120,000)(1 – 40%)PVAF(14%,10) = $250,373.55

Question 47

47) Monteregie Auto Services is considering an opportunity to invest $550,000 in a capital asset that will generate additional after-tax operating income of $200,000 per year. The asset has a six-year life, a CCA rate of 20 percent, and an expected salvage value of $60,000. The project has a beta of 1.5. The company’s cost of capital is 12 percent and marginal tax rate is 35 percent. The risk-free rate is 4.5 percent and the market risk premium is 6 percent. What is the present value of the after-tax operating cash flows?

a) $512,526
b) $534,483
c) $788,501
d) $822,281

Answer 47

Answer: c, The project’s discount rate = 4.5% + 1.5*(6%) = 13.5%

PV(CFAT) = $200,000*PVAF(13.5%,6) = $788,500.91

Question 48

48) Canadian Donuts is looking at a new investment opportunity, which will require the purchase of a capital asset of $1 million and additional raw materials inventory of $50,000. The project is expected to generate operating revenue of $750,000 per year, and the associated operating expenses are estimated at $350,000 per year. The project has a five-year economic life. This capital asset belongs to asset class 8, which has a CCA rate of 20 percent. What is the CCA expense for year 3?

a) $115,200
b) $128,000
c) $144,000
d) $180,000

Answer 48

Answer: c, CCA3 = $1,000,000(1 – 20%/2)(1 – 20%)*20% = $144,000

Question 49

49) Maple Syrup Food is considering a six-year expansion project that requires an initial investment of $350,000 for the purchase of a new capital asset with a CCA rate of 20 percent. The costs to install the asset are $25,000. The projected annual sales revenue and costs are $200,000 and $90,000 per year, respectively. The appropriate discount rate is 10 percent. The firm’s marginal tax rate is 40 percent. What is the fourth year CCA expense?

a) $35,840
b) $38,400
c) $40,320
d) $43,200

Answer 49

Answer: d, CCA4 = $(350,000 + 25,000)(1 – 20%/2)(1 – 20%)2*20% = $43,200

Question 50

50) The Beer Brewing Company is interested in a new eight-year project. The project calls for an initial cash outlay of $1,000,000: $850,000 for new equipment, $100,000 for installation costs, and $50,000 for additional net working capital. The asset has a CCA rate of 30 percent and an expected salvage value of $75,000. The project will generate additional operating profit of $325,000 per year. What is the UCC at the end of year 3?

a) $395,675
b) $325,850
c) $354,025
d) $416,500

Answer 50

Answer: a, Ending UCC3 = $(850,000 + 100,000)(1 – 30%/2)(1 – 30%)2 = $395,675

Question 51

51) Hull Small Business is considering an expansion project that requires $135,000 for the purchase of capital assets and $35,000 for additional inventory. The project will generate after-tax operating income of $50,000 per year. The project has a five-year economic life and a CCA rate of 20 percent. What is the ending UCC upon termination of the project?

a) $44,237
b) $49,766
c) $55,706
d) $62,669

Answer 51

Answer: b, Ending UCC5 = $135,000(1 – 20%/2)(1 – 20%)4 = $49,766.40

Question 52

52) Laurentide Resort Corporation is considering a seven-year project that requires an initial investment of $525,000 and generates annual after-tax operating cash flow of $225,000. The asset has a CCA rate of 30 percent and an expected salvage value of $65,000. The firm’s marginal tax rate is 40 percent. What is the CCA tax savings for year 5?

a) $15,126
b) $18,368
c) $37,816
d) $45,919

Answer 52

Answer: b, CCATS5 = $525,000(1 – 30%/2)(1 – 30%)330%40% = $18,367.65

Question 53

53) Suppose a project requires a capital investment of $300,000. The project will last for six years, at which time the asset will be sold for $90,000. The asset will be depreciated on a declining balance basis at a CCA rate of 20 percent. The firm’s marginal tax rate is 40 percent. The firm’s required rate of return is 8 percent. Assume the asset class remains open after the asset is sold. What is the present value of the CCA tax savings for the project?

a) $63,472.64
b) $65,950.56
c) $66,335.32
d) $66,720.08

Answer 53

Answer: c,

Question 54

54) Ontario Courier Service is considering investing in a capital asset that costs $64,000. The project also requires an investment in net working capital of $8,000. The project will generate annual after-tax operating income of $20,800 for the next four years. The asset has a CCA rate of 20 percent and is expected to sell for $7,200 at the end of four years. The firm’s cost of capital is 15 percent and marginal tax rate is 35 percent. Assume the asset class remains open after the asset is sold. What is the ending after-tax cash flow?

a) $7,398
b) $15,200
c) $21,855
d) $23,002

Answer 54

Answer: b, ECF = $7,200 + $8,000 = $15,200

Question 55

55) Amazing Lace has an opportunity to invest in a ten-year project that requires an initial investment of $2 million in a capital asset with a CCA rate of 20 percent. The initial net working capital requirement is $200,000, which will remain unchanged throughout the life of the project. The capital asset is expected to sell for $75,000 when the project terminates. Assume the asset class is closed upon termination of the project. The firm’s cost of capital is 10.5 percent and marginal tax rate is 40 percent. What is the ending after-tax cash flow?

a) $208,363.24
b) $275,000.00
c) $330,899.35
d) $341,636.76

Answer 55

Answer: d, Ending UCC = $2,000,000(1 – 20%/2)(1 – 20%)9 = $241,591.91; ECF = $75,000 + $200,000 – $(75,000 – 241,591.91)*40% = $341,636.76

Question 56

56) Queue de Castor Foods is considering the purchase of a new capital asset for $35,000. The asset has an economic life of three years, a CCA rate of 20 percent, and expected salvage value of $5,000. The project also requires an investment in net working capital of $4,500. Assume the asset class remains open after the asset is sold. The firm’s cost of capital is 14 percent and marginal tax rate is 40 percent. What is the present value of the terminal after-tax cash flow?

a) $2,319.20
b) $6,412.23
c) $9,900.48
d) $10,505.26

Answer 56

b

Question 57

57) Bugs Buster is considering investing in a new risky project that requires $100,000 for the purchase of new equipment and $20,000 for additional net working capital. The equipment has a five-year life and a CCA rate of 30 percent. The equipment is expected to sell for $8,500 at the end of the project. Assume the asset class remains open after the asset is sold. The firm’s cost of capital is 12 percent and marginal tax rate is 35 percent. The risk premium for the project is 3 percent. What is the present value of the terminal after-tax cash flow?

a) $14,169.54
b) $16,171.67
c) $16,241.76
d) $18,536.69

Answer 57

a

Question 58

58) Canadian Auto Shop Services has an opportunity to invest $550,000 in a new project that will generate additional operating profit of $200,000 per year. The asset has a six-year life, a CCA rate of 30 percent, and an expected salvage value of $60,000. The project has a beta of 1.5. The company’s cost of capital is 12 percent and marginal tax rate is 35 percent. The risk-free rate is 4.5 percent and the market risk premium is 6 percent. Assume the asset class remains open after the asset is sold. What is the project’s NPV?

a) $108,680
b) $137,415
c) $384,655
d) $425,214

Answer 58

a
Determine the appropriate discount rate for the project using the project beta.
= 4.5% + 1.5*6% = 13.5%

CF0 = $550,000; PV(CFAT) = $200,000(1 – 35%)PVAF(13.5%,6) = $512,525.59

solve for PV (CCATs) = 118,088.8

solve for PV(ECF) =
28,065.71
NPV = –$550,000 + $512,525.59 + $118,088.80 + $28,065.71 = $108,680.10

Question 59

59) Toronto Skaters is considering the purchase of a new computer system for $150,000. The asset has an economic life of four years, a CCA rate of 45 percent, and expected salvage value of $10,000. The project also requires an investment in net working capital of $7,500, which will be recovered at the end of the project. The project is expected to generate after-tax operating income of $80,000 per year. Assume the asset class remains open after the asset is sold. The firm’s cost of capital is 18 percent and marginal tax rate is 40 percent. What is the NPV of the project?

a) $104,845.95
b) $18,763.97
c) $105,330.16
d) $108,477.53

Answer 59

a
Answer: a, CF0 = $150,000 + $7,500 = $157,500;

PV(CFAT) = $80,000*PVAF(18%,4) = $215,204.94

PV (CCATS) = 38,114.7

PV(ECF)=(10,000+7,500)/1.184=$9,026.31

NPV = –$157,500 + $215,204.94 + $38,114.70 + $9,026.31 = $104,845.95

Question 60

60) The Mont Royal Lighting Corporation is considering investing $100,000 in machinery that would generate operating cash flows of $30,000 in year 1, $60,000 in year 2, $10,000 in year 3, $50,000 in year 4, and $40,000 in year 5. The equipment has a CCA rate of 30 percent and is expected to have no salvage value at the end of five years. Assume the asset class remains open after the asset is sold. The firm’s marginal tax rate is 38 percent. If the appropriate discount rate is 10 percent, what is the project’s NPV?

a) $16,087.86
b) $20,903.24
c) $70,564.72
d) $75,380.11

Answer 60

Answer: a, CF0 = $100,000
CFAT = CFBT*(1 – 38%)
CFAT of years 1-5: $18,600, $37,200, $6,200, $31,000, $24,800

PV (CFATs) = 88,883.31

PV (CCATS) = 27,204.55

NPV = –$100,000 + $88,883.31 + $27,204.55 = $16,087.86

Question 61

61) Maritimes Toy Corporation(MTC) is considering investing in a piece of new equipment worth $50,000. The equipment will increase operating revenue by $10,000 per year for ten years. The equipment is expected to have no salvage value at the end of ten years, and capital cost allowance is claimed at 20 percent on a declining balance. The corporate tax rate is 38 percent, and MTC’s opportunity cost of capital is 9 percent. Assume the asset class remains open after the asset is sold. The project’s NPV is closest to:

a) $2,351.96
b) $3,321.44
c) $26,739.06
d) $27,708.54

Answer 61

Answer: a, CF0 = $50,000;
PV(CFAT) = $10,000(1 – 38%)PVAF(9%,10) = $39,789.48

PV (CCATS) 12,562.48

		NPV = –$50,000 + $39,789.48 + $12,562.48 = $2,351.96

Question 62

62) Use the following two statements to answer this question:
I. Sensitivity analysis examines how an investment’s NPV changes as we change the values of more than one input variable at a time.
II. Scenario analysis examines how an investment’s NPV changes as we change the value of one input variable at a time.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 62

b

Question 63

63) Which of the following is FALSE about scenario analysis?

a) It can provide important information because estimates will rarely be completely accurate and can often be very wrong.
b) It is often conducted in the form of a “what if” analysis.
c) It allows firms to determine which of their estimates is the most critical in the final decision.
d) It allows firms to account for interactions among the variables and for the fact that many variables can be related to external variables.

Answer 63

c

Question 64

64) Which of the following is the purpose of providing a sensitivity analysis?

a) To determine which variable is most critical to the success or failure of a project.
b) To develop a probability distribution for a project.
c) To evaluate the worst-case scenarios.
d) To examine all possible outcomes of a project.

Answer 64

a

Question 65

65) In which of the following do we change one variable while holding the other variables constant to examine the impact on the NPV of a project?

a) NPV break-even analysis
b) Real option valuation
c) Scenario analysis
d) Sensitivity analysis

Answer 65

d

Question 66

66) Use the following statements to answer this question:
I. The break-even NPV is the same as finding the IRR of the project
II. By assessing the break-even NPV, managers estimate the break-even level of operating cash flows required for the project.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 66

a

Question 67

67) A manager is considering the following: taking a project this fiscal year or waiting for a few years before committing. What method should she use to take this decision?

a) Break-even analysis
b) Scenario analysis
c) Real option analysis
d) Sensitivity analysis

Answer 67

c

Question 68

68) Which of the following is (are) useful in examining the relationship between the sales and profitability of an investment project?
I. Scenario analysis
II. Sensitivity analysis
III. Real option analysis

a) II only.
b) I and II only.
c) I and III only.
d) II and III only.

Answer 68

a

Question 69

69) An analysis of the degree to which a project’s NPV depends on the underlying variables is called a(n):

a) Scenario analysis
b) Sensitivity analysis
c) Optimality analysis
d) Break-even analysis

Answer 69

b

Question 70

70) Use the following two statements to answer this question:
I. Real option valuation takes into account that a firm responds to different circumstances and changes its operating characteristics.
II. Real option valuation places great weight on the flexibility involved in a firm’s operations.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 70

a

Question 71

71) Use the following two statements to answer this question:
I. The break-even discount rate is the capital cost of the project
II. The NPV break-even operating cash flow is the level of annual operating cash flow required for a project to produce an NPV of zero.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct

Answer 71

d

Question 72

72) The NPV break-even operating cash flow is:

a) The level of annual operating cash flow required for a project to produce an operating profit of zero.
b) The level of annual operating cash flow required for a project to produce an NPV of zero.
c) The level of annual operating cash flow required for a project to produce an NPV close to zero.
d) The level of annual operating cash flow required for a project to produce an accounting profit of zero.

Answer 72

b

Question 73

73) The Bits’n Bytes Computer Company has been requested by a large brokerage firm to submit a bid for a new computer system. The system would be installed in 20 branch offices per year for the next three years. Bits’n Bytes would need to purchase $250,000 worth of specialized equipment. The CCA rate would be 25 percent. Bits’n Bytes will be able to sell the equipment in three years for $125,000. Labour and material costs would be $35,000 per site. The company would need to invest $60,000 in net working capital. The relevant tax rate is 44 percent. Assume the asset class remains open after the asset is sold. If Bits’n Bytes requires a 16% return on investment, their minimum bid (price per system) should be:

a) $22,950.93
b) $38,350.93
c) $40,983.80
d) $68,483.80

Answer 73

c

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Question 74

74) Suppose a five-year project requires an initial capital investment of $600,000 and an initial net working capital investment of $30,000. The project is expected to provide operating revenue of $400,000 per year. The associated operating costs are expected to be $175,000 per year. The capital asset belongs to Class 7 and has a CCA rate of 15 percent. The asset is expected to sell for $168,000 when the project terminates. Assume the asset class remains open after the project ends. The firm’s marginal tax rate is 40 percent and cost of capital is 10 percent. What impact would it have on the project’s NPV if the operating revenue falls by 5 percent?

a) NPV decreases by 21.85%
b) NPV decreases by 38.84%
c) NPV decreases by 46.19%
d) NPV decreases by 63.51%

Answer 74

b

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Question 75

75) Suppose a seven-year project requires an initial capital investment of $475,000 and an initial net working capital investment of $25,000. The project is expected to provide operating revenue of $350,000 per year. The associated operating costs are expected to be $150,000 per year. The capital asset belongs to Class 8 and has a CCA rate of 20 percent. The asset is expected to sell for $36,000 when the project ends. Assume the asset class remains open after the asset is sold. The firm’s marginal tax rate is 40 percent and cost of capital is 8 percent. What impact would it have on the project’s NPV if the operating costs increase by 5 percent?

a) NPV decreases by 8.22%
b) NPV decreases by 8.66%
c) NPV decreases by 8.96%
d) NPV decreases by 10.96%

Answer 75

a

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Question 76

76) Suppose a six-year project requires an initial capital investment of $425,000 and an initial net working capital investment of $50,000. The project is expected to provide operating revenue of $270,000 per year. The associated operating costs are expected to be $130,000 per year. The capital asset belongs to Class 9 and has a CCA rate of 30 percent. The asset is expected to sell for $40,000 when the project terminates. Assume the asset class remains open when the asset is sold. The firm’s marginal tax rate is 40 percent and cost of capital is 8 percent. What impact would it have on the project’s NPV if the cost of capital were 10 percent?

a) NPV decreases by 23.14%
b) NPV decreases by 38.04%
c) NPV decreases by 48.20%
d) NPV decreases by 61.41%

Answer 76

b

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Question 77

77) A company is planning to invest in a project, which requires the purchase of capital assets of $200,000 and additional net working capital of $20,000. The assets have a five-year life, a CCA rate of 30 percent, and an expected salvage value of $35,000. The annual costs for the project’s operations are $50,000. The company’s effective tax rate is 40 percent and the cost of capital is 12 percent. Assume the asset class remains open after the assets are sold. What is the break-even pre-tax annual operating revenue?

a) $114,907
b) $38,944
c) $64,907
d) $140,384

Answer 77

a

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Question 78

78) A company is considering investing in a project, which requires the purchase of a new machine for $250,000. The asset has a six-year life, a CCA rate of 30 percent, and an expected salvage value of $30,000. The selling price of the product is $40 per unit, while the variable cost is $18 per unit and the fixed costs are $50,000 per year. The company’s effective tax rate is 40 percent and cost of capital is 10 percent. Assume the asset class remains open after the asset is sold. At what level of sales will the company break even?

a) 3,102 units
b) 4,011 units
c) 5,170 units
d) 6,685 units

Answer 78

c

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Question 79

79) Suppose an investment with an initial cost of $10,000 is estimated to produce after-tax cash flows of $3,000 per year for 8 years. How low can the annual after-tax cash flows be before the NPV of the investment equals zero? Assume that the appropriate discount rate is 8 percent.

a) $1,250
b) $1,260
c) $1,740
d) $2,262

Answer 79

c
be annual CFAT
= 10,000 / PVAF (8%, 8)

Question 80

80) A software firm is considering developing a new financial planning software package. This new project is expected to sell 5,000 units per year and generate net operating cash flow of $100 per unit for the next five years. The relevant discount rate is 15 percent and the initial investment is $1.25 million. At what annual level of sales would it make sense to abandon the project if the project can be sold for $150,000 after the first year? Ignore taxes.

a) less than 447 units
b) less than 525 units
c) more than 3,340 units
d) less than 3,729 units

Answer 80

b

be units = (150000/ PVAF (15%,4)) x (1/100)

Question 81

81) Use the following two statements to answer this question:
I. Expansion projects are projects that would add something extra to the firm in terms of sales or cost savings. The incremental cash flows arising from such investment decisions are the new cash flows.
II. Replacement projects are projects that involve the replacement of an existing asset with a new one. The incremental cash flows arising from such investment decisions are the new operating expenses.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 81

c

Question 82

82) Use the following statements to answer this question:
I. Replacement projects are projects that involve the replacement of an existing project. The incremental cash flows are the difference between the costs and the revenues of the two projects.
II. The discount rate of the two projects must be the same.

a) I and II are correct.
b) I and II are incorrect.
c) I is correct, II is incorrect.
d) I is incorrect, II is correct.

Answer 82

c

Question 83

83) A firm is considering the purchase of a new computer system at $180,000 to replace the existing system. The existing system has a market value of $50,000 today and an expected salvage value of $10,000 at the end of five years. The new system will have a life of five years and is expected to sell for $50,000 at the end of five years. The new system will save the firm $60,000 per year in operating expenses over the life of the system. Both computer systems belong to asset class 45, which has a CCA rate of 45 percent. The firm’s marginal tax rate is 40 percent and its cost of capital is 10 percent. What is the NPV of the replacement decision?

a) $63,788.32
b) $69,997.54
c) $77,376.05
d) $83,585.26

Answer 83

a

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Question 84

84) A large printing company is considering purchasing a new printing press to replace the existing one that cost the company $1 million five years ago. The new machine will cost the company $1.8 million, has an economic life of ten years, and an expected salvage value of $150,000. The old machine can be sold for $200,000 today or could be sold for $10,000 in ten years. Both machines have a CCA rate of 30 percent. The company projects that operating profit will increase by $400,000 per year. The company’s tax rate is 40 percent and the cost of capital is 12 percent. What is the NPV of the replacement decision?

a) $220,903.91
b) $224,123.64
c) $274,065.62
d) $277,285.35

Answer 84

a

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Question 85

85) A manufacturing company is considering purchasing a new machine to replace the existing one to improve production efficiency. The new machine will cost the company $200,000 and is expected to sell for $15,000 in ten years. The old machine has a market value of $50,000 today and could be sold for $5,000 in ten years. Both machines have a CCA rate of 30 percent. With the new machine, the company expects $50,000 savings in operating expenses per year. The company’s tax rate is 40 percent and the cost of capital is 15 percent. What is the present value of the incremental CCA tax savings generated by the replacement decision?

a) $36,402.57
b) $36,732.15
c) $48,866.33
d) $49,195.91

Answer 85

b

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Question 86

86) Which of the following is NOT a true statement?

a) Inflation always affects future levels of sales and expenses equally.
b) Inflation affects the firm’s cost of capital.
c) Actual cash flows should be discounted with nominal discount rates.
d) Inflation-adjusted cash flows should be discounted with real discount rates

Answer 86

a

Question 87

87) Which of the following are ways that inflation impacts the capital budgeting process?
I. Inflation affects future expected cash flows.
II. Inflation is reflected in the firm’s discount rate.
III. Inflation increases the general price level.

a) III only.
b) I and II only.
c) I and III only.
d) all.

Answer 87

d

Question 88

88) Use the following statements to answer this question:
I. Using real cash flows with a real discount rate yields the correct result.
II. Tax savings for CCA are normally reported in a given year dollars, so they are real values.

a) I and II are correct
b) I and II are incorrect
c) I is correct and II is incorrect
d) I is incorrect and II is correct

Answer 88

c

Question 89

89) A proposed ten-year project has the first year sales revenue and cost projected at $300,000 and $100,000, respectively. Sales revenue is expected to grow at 3 percent per year, while the costs will grow at 5 percent per year. The firm’s marginal tax rate is 35 percent and required return is 9 percent. What is the present value of the after-tax operating cash flows generated by the project?

a) $898,126
b) $914,932
c) $1,625,000
d) $1,641,250

Answer 89

a

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Question 90

90) A project will cost $50,000 to initiate and will generate real cash flows of $40,000 in each of the next two years. The nominal discount rate has been estimated to be 10 percent per year. Expected inflation is 4 percent over the next two years. What is the NPV of the project?

a) $19,421.49
b) $21,573.55
c) $23,573.55
d) $25,496.63

Answer 90

c

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Question 91

91) A project will cost $150,000 to initiate and will generate nominal cash flows of $80,000 in each of the next three years. The real discount rate has been estimated to be 10 percent per year. Expected inflation is 3 percent over the next three years. What is the NPV of the project?

a) $37,934.15
b) $42,303.08
c) $48,948.16
d) $76,288.91

Answer 91

a

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Question 92

92) Suppose a new machine costs $100,000 and will provide nominal operating income of $50,000 in each of the next four years. The machine belongs to asset class 9, which has a CCA rate of 30 percent. The machine is expected to be sold for $25,000 at the end of four years. The real discount rate has been estimated to be 8 percent per year. Expected inflation is 2.5 percent over the next four years. The firm’s marginal tax rate is 38%. Assume there are other assets in the asset class when the machine is sold. What is the NPV of the project?

a) $35,435.83
b) $44,427.84
c) $94,761.86
d) $107,358.25

Answer 92

a

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Question 93

93) A firm is considering a project that requires an initial cash outflow of $1,000,000 for the purchase of a capital asset, which has an eight-year life and a CCA rate of 20 percent. The expected salvage value of the asset is $75,000 at the end of eight years. The project will generate sales revenue of $450,000 in the first year, which will grow at 5 percent per year in the subsequent years. Variable costs will be $200,000 for the first year, which will also grow at 5 percent per year. The firm’s marginal tax rate is 40 percent and required return is 12 percent. What is the project’s NPV?

a) $123,498
b) $166,707
c) $1,402,183
d) $1,509,326

Answer 93

a

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Question 94

94) A firm is considering purchasing a new machine, which costs $500,000 and has a six-year life, a CCA rate of 30 percent, and an expected salvage value of $45,000. The project will generate sales revenue of $200,000 in the first year, which will grow at 5 percent per year in the subsequent years. Variable costs will be $80,000 for the first year, which will grow at 7 percent per year. The firm’s marginal tax rate is 35 percent and required return is 10 percent. What is the project’s NPV?

a) $12,264
b) $25,376
c) $497,546
d) $519,351

Answer 94

a

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