FIN 3400 Chapter 12 Assignment Questions and Answers- Florida International University

FIN 3400 Chapter 12 Assignment Questions and Answers- Florida International University What is pro forma analysis? Multiple choice question. Comparing the financial statements from one time period to another Ascertaining how an action would affect a firm's taxes Reviewing historical data to determine trends Estimation of future project cash flows using only the relevant parts of the financial statements What is an incremental cash flow? Multiple choice question. A cash flow that increases when a new project is implemented A cash flow that affects a firm's revenues A cash flow that either increases or decreases when a new project is implemented A cash flow that changes when one more unit is produced Which one of these represents an opportunity cost? Multiple choice question. Assigning a current employee to a new project Buying some new equipment for use in a new project Hiring a new employee for a recently approved project Conducting market research to determine if a new product is feasible 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? Multiple choice question. Sunk cost Opportunity cost Incremental cost Marginal cost Which one of these is an example of the substitution effect? Multiple choice question. Hiring Joe rather than Larry to oversee a new project Telling a customer that either one of two existing products will meet their need The variable costs of a firm's existing product increases due to a new product requiring the same resources Current employee costs are lowered due to the automation processes implemented by a new project In proforma analysis, what determines whether or not an account on the balance sheet or income statement is relevant to a project? Multiple choice question. If the account was listed on the latest financial statement, then it is relevant. If the project causes an account value to change, then it is relevant. Income statement accounts are all relevant but balance sheet accounts are not. Only income and variable expense accounts are relevant. Select all that apply How can you determine if a cash flow is incremental to a project? Select all that apply. Multiple select question. The cash flow is unaffected by a new project. The cash flow occurs only if a new project is implemented. The cash flow will disappear when the project ceases. The cash flow changes only when a new project is implemented. How is bond interest included in the analysis of a new project? Multiple choice question. Bond interest increases the amount of net working capital required for a project and is treated as a cash outflow for the project Bond interest is ignored when analyzing a new project because it is a financing expense. Bond interest is added as an expense on the project's pro forma income statement 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 Select all that apply Which of these represent opportunity costs? Select all that apply. Multiple select question. Building a new building on a vacant lot owned by the firm The research and development costs related to a new project Using a piece of company equipment that has been sitting idle for two years in a new project Using a current employee who is about to be laid off to run a project on a day by day basis What are the key differences between the free cash flows of a firm and those of a project? Select all that apply. Multiple choice question. Firm free cash flows consider the effects of taxes while project free cash flows ignore tax effects. Firm free cash flows are computed using a subset of a firm's pro forma statements while project free cash flows use the entire financial statements. Firm free cash flows are actual values while project free cash flows are estimates. Firm free cash flows ignore depreciation expense while project free cash flows include depreciation. Why are sunk costs excluded from project analysis? Multiple choice question. The costs have been incurred and cannot be recouped with or without the project. Sunk costs occur only after a project has been fully implemented. Sunk costs only occur if a project is rejected. Sunk costs are firmwide costs. Select all that apply What types of costs are included in an asset's depreciable basis? Select all that apply. Multiple select question. Purchase price of the asset An adjustment downward to record the selling price of the asset replaced Sales tax and freight charges Installation and testing costs Select all that apply Which of these illustrates a complementary effect? Select all that apply. Multiple select question. Customers buy the new product rather than an existing product A decrease in the overall level of sales of existing products caused by the introduction of a new product 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 How can straight-line depreciation be defined? Ignore the half-year convention. Multiple choice question. Total cost of an asset minus its projected ending market value divided by the asset's life Total amount to be depreciated spread evenly over an asset's life The depreciable basis minus the projected ending market value divided by the asset's life Total cost of an asset divided by the asset's life 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? Multiple choice question. ($28,000 - $5,000)/5 ($28,000 - $7,800)/5 ($28,000 + $7,800)/5 $28,000/5 How are the dividends paid on stock included in the analysis of a new project? Multiple choice question. They are not included because stock dividends are a financing cost. Dividends are treated as a cash outflow for the time period in which they are paid. Financing costs, such as dividends, are considered in the component costs of capital when a project's WACC is calculated. Dividends are included as an expense in the project's pro forma income statement. How is operating cash flow (OCF) defined? Multiple choice question. EBIT (1 - Tax rate) + Depreciation (EBIT + Depreciation)(1 - Tax rate) EBIT - Taxes EBIT (Tax rate) + Depreciation Free cash flows for which one of the following are affected by estimation error? Multiple choice question. Neither firm nor project free cash flows Both firm and project free cash flows Project free cash flows only Firm free cash flows only 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? Multiple choice question. $546 $2,361 $3,661 $1,646 Reason: OCF = {[280($46 - $28)] - $3,100 - $1,100}(1 - 0.35) + $1,100 = $1,646 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. $344,500 $340,400 $347,900 $353,500 Reason: Depreciable basis = $318,000 + $19,000 + $7,500 + $3,400 = $347,900 Which one of these represents a time zero project cash flow? Multiple choice question. Purchase of new equipment to start a project Operator hired to run new equipment Sale of equipment at the end of the project Annual maintenance on project equipment Which one of these computes the amount of annual depreciation using the straight-line method? Ignore the half-year convention. Multiple choice question. (Depreciable basis - Ending book value)/Life of asset (Asset purchase price - Ending book value)/Life of asset Depreciable basis/Life of asset Asset cost/Life of asset Select all that apply 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. Multiple select question. Zero market value Zero book value Zero future use to the firm Usable by another of the firm's existing projects 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. Multiple choice question. ($28,000 + $2,000 - $5,000)/6 ($28,000 + $2,000 + $5,000)/6 ($28,000 - $5,000)/6 $28,000/6 How is the gain or loss on a sale of equipment determined? Multiple choice question. Market value - Book value Book value - Market value Book value + Market value Market value - Initial cost Which one of these is a correct formula for OCF, assuming there is no interest expense? Multiple choice question. Net income - Taxes + Depreciation Net income + Taxes Net income + Depreciation Net income – Depreciation 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? Multiple choice question. $13,100 $9,200 $11,600 $8,400 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 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? Multiple choice question. $583.80 $730.00 $430.00 $283.80 Reason: OCF = ($1,800 - $620 - $450 - $300)(1 - 0.34) + $300 = $583.30 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? Multiple choice question. An amount equal to the initial NWC requirement Zero An amount equal to CF0 An amount equal to the highest NWC requirement for any one year Select all that apply 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. Multiple select question. Management's time spent in determining which equipment to purchase Shipping costs to have the equipment delivered Installation and initial testing costs Purchase price of the equipment Select all that apply 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. Multiple select question. $5,000 $5,000 × (1 - 0.35) $2,400 $16,000 × (1 - TC) Select all that apply 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. Multiple select question. Selling the project's equipment Scrapping fully depreciated equipment at a zero selling price Scrapping equipment that has a positive book value but no market value Trading in the project's equipment on new equipment for other projects Over how many tax years will a 3-year asset be depreciated given the half-year convention? Multiple choice question. 5 years 3 years 4 years 2 years Which one of these explains the after-tax cash flow formula for the sale of an asset? Multiple choice question. The cash flow equals the book value plus the after-tax value of any gain or loss on the sale. The cash flow equals the market value plus the after-tax value of any gain or loss on the sale. The cash flow equals the after-tax value of any gain or loss on the sale. The cash flow equals the sale price plus the after-tax value of any gain or loss on the sale. What is the double-declining balance (DDB) method of depreciation? Multiple choice question. The depreciation is equal to twice the straight-line amount over the life of an asset. Depreciation for each year is equal to twice the straight-line amount until an asset is fully depreciated. The depreciation rate is applied each year to the average of an asset's beginning and ending book values for the year. The depreciation rate is 200 percent of the straight-line rate with the rate applied to the current book value. 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? Multiple choice question. $9,200 $7,185 $13,100 $4,200 Reason: OCF = ($8,200 - $5,300)(1 - 0.35) + $5,300 = $7,185 Which one of these is a feature of MACRS depreciation? Multiple choice question. Depreciation commences with an accelerated method and later switches to a straight-line method. Depreciation is computed using the DDB method over the asset's life. MACRS ignores the half-life convention. MACRS produces a higher book value of an asset during the early years as compared to straight-line depreciation. Select all that apply 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. Multiple select question. A cash outflow of (0.05 × $120,000) is recorded at time zero. 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 × ($190,000 - $160,000)] in year 3. Select all that apply 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. Multiple select question. $16,000 -$34,000 -$3,500 $0 The half-year convention is based on which of these assumptions? Multiple choice question. 50 percent of the assets are acquired on the first day and the other 50 percent are acquired on the last day of a given period. Any asset purchased during a given period is assumed to be only half paid for during that period. Any asset placed in service during a given period is assumed to be placed in service on the last day of the given period. 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? Multiple choice question. Section 179 grants a tax credit, or dollar for dollar reduction in taxes, in an amount equal to the cost of the eligible property acquired. Section 179 allows depreciation deductions in excess of a firm's taxable income, thereby allowing firms to receive a tax refund of the excess amount. Section 179 allows eligible property, up to stated limits, to be fully expensed in the year of purchase. Section 179 allows firms established within the past 5 years to fully depreciate all asset purchases in the year of acquisition. What does accelerated depreciation indicate? Multiple choice question. Depreciation of an asset is completed within the first year. Depreciation in the first half of an asset's life is greater than half of the assets value. Depreciation is taken for an entire 12-month period during the first year. Depreciation of an asset is done evenly over the asset's life with an entire year's worth deducted in year 1. 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? Multiple choice question. $3,697.92 $8,308.14 $7,395.84 $11,093.76 Reason: Book value4 = $64,200 × (1 - 0.2 - 0.32 - 0.192 - 0.1152) = $11,093.76 Why would a firm prefer to use MACRS rather than straight-line depreciation for tax purposes? Multiple choice question. The tax deduction from depreciation is greater in the early years. The firm's taxes will be lower over the life of the project. The total amount of depreciation will be greater with MACRS. The IRS requires that MACRS be used. 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? Multiple choice question. $880 $13,200 $1,760 $3,080 Reason: Depreciation2 = ($15,400/5) - $2,200 = $880 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? Multiple choice question. Zero An amount equal to the initial NWC requirement An amount equal to the highest NWC requirement for any one year An amount equal to CF0 Select all that apply Which of these are cash flows that apply to a replacement problem? Select all that apply. Multiple select question. Depreciation lost if existing asset is sold Cost of new asset ATCF of an existing asset at its normal life-end Current book value of existing asset Select all that apply 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. Multiple select question. $2,400 $5,000 × (1 - 0.35) $5,000 $16,000 × (1 - TC) 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? Multiple choice question. ATCF = $210,000 + ($68,000 - $210,000)(1 - 0.34) ATCF = $68,000(1 - 0.34) Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) Book value = $210,000 - (3/5 × $210,000); ATCF = $68,000 + (Book value - $68,000)(1 - 0.34) Reason: Book value = $210,000 - (3/5 × $210,000); ATCF = Book value + ($68,000 - Book value)(1 - 0.34) Which one of these represents a limit placed on Section 179 deductions? Multiple choice question. Annual deduction cannot exceed a firm's retained earnings Taxable income from the active conduct of the firm $2.5 million maximum cost of eligible property (for 2010) Maximum deduction of $2 million A cost-cutting project is least apt to affect which one of these? Multiple choice question. Revenue Depreciation Variable costs Net working capital 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? Multiple choice question. $1,209.57 $2,200.44 $815.03 $0 Reason: Book value3 = $13,200 × (1 - 0.1667 - 0.3333 - 0.3333) = $2,200.44 Select all that apply Which of these conditions generally occur in situations where equivalent annual cost (EAC) applies as the method of decision making? Select all that apply. Multiple select question. Both assets may produce the same level of sales. Both assets have the same projected life. Both assets cost the same. Two assets can be used for the same purpose 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? Multiple choice question. $13,200 $3,080 $1,760 $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 Which question is the basis for determining which one of a set of alternative assets with differing lives is preferable? Multiple choice question. Which asset has the longest life? Which asset has the highest resale value? Which asset will produce the least negative EAC? Which asset provides the greatest depreciation tax shield? How can a replacement problem be defined? Multiple choice question. Buying a new asset to replace an asset that is fully depreciated and no longer usable Buying a new asset which will be used in place of an existing asset that is still usable Selling an asset that a firm is currently utilizing Selling an asset while it still has a positive book value What is the second step of the EAC process? Multiple choice question. Determine the relevant costs of each project Determine how an asset will be replaced when it wears out. Find the present value of each of a project's cash flows and sum those amounts. Find the annuity payment that has the same present value as the sum of the present values of a project's cash flows 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? Multiple choice question. ATCF = $138 + ($138 - $96)(1 - 0.35) ATCF = $96 + ($96 - $138)(1 - 0.35) ATCF = $96 + ($138 - $96)(1 - 0.35) ATCF = $138 + ($96 - $138)(1 - 0.35) 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? Multiple choice question. NPV = -$32,000 - $2,600 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133 NPV = -$2,600/1.13 - $2,600/1.132 - $2,600/1.133 NPV = -$32,000 - $2,600/1.13 - $2,600/1.132 - $2,600/1.133 NPV = -$32,000 + $2,600/1.13 + $2,600/1.132 + $2,600/1.133 What typifies a cost-cutting project? Multiple choice question. The new asset qualifies as Section 179 property thereby lowering future depreciation costs. No revenue is generated by the project. The new asset lowers the required working capital. The cost of the new assets is less than the market value of the existing assets. 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? Multiple choice question. -$18,406.67 -$19,894.14 -$22,933.01 -$22,308.81 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 Which one of these is a key assumption in situations where EAC is used as the decision method? Multiple choice question. Whenever the chosen asset wears out, the project will double in size and two assets will be required as replacements. Whenever the chosen asset wears out, it will be replaced with the alternative asset. Whenever the chosen asset wears out, it will not be replaced. Whenever the chosen asset wears out, it will be replaced with an identical asset. Why are a firm's target capital structure values used in computing the average flotation cost? Multiple choice question. The target capital structure accurately reflects the current levels of debt and equity. There is no real reason. It is just common practice. The firm will issue securities in these percentages over the long term. The market weights of a firm's capital structure are difficult to compute. In essence, the EAC process makes a decision based on which one of these? Multiple choice question. Cost of an asset Life of an asset Perpetuity payment amount The replacement period How is free cash flow defined? Multiple choice question. Cash flow that avoids taxation Cash flow above that which is expected from a new project Cash flow arising from external sources Cash flow available for distribution to a firm's investors What is the first step in the EAC process? Multiple choice question. Determine which project has the least negative EAC Find the sum of the present values of the cash flows for one iteration of each project Determine the sales levels for each project. Find the perpetuity payment that produces a sum of present values that matches that of each project 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? Multiple choice question. N = 4, I = 12, PV = 0, FV = 46,900, CPT PMT N = 4, I = 12, PV = 46,900, PMT = 0, CPT FV N = 4, I = 12, PMT = 46,900, FV = 0, CPT PV N = 4, I = 12, PV = 46,900, FV = 0, CPT PMT 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? Multiple choice question. -$87,400.00 -$95,308.19 -$99,416.45 -$90,543.97 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 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? Multiple choice question. $38,000/(1 + 0.067) $38,000/(1 - 0.067) $38,000 × (1 - 0.067) $38,000 × (1 + 0.067) Select all that apply Which of these correctly define free cash flow? Select all that apply. Multiple select question. FCF = EBIT + Depreciation - Taxes FCF = Net income - Change in gross fixed assets - Change in net operating working capital FCF = OCF - Investment in operating capital FCF = [EBIT(1 - Tax rate) + Depreciation] - [Change in gross fixed assets + Change in net operating working capital]