Question 1(16 points)

Question 1 options:

Use the following information toanswer the 8 questions(filling in the blanks) that follow it. When answering the questions,DO NOT use dollar signs, USE commas to separate thousands, DO NOT use parenthesis to denote negative numbers, USE the negative sign and place it in front of first digit of your answer when your answer is a negative number. Round to the nearest dollar (do not enter decimals). For example, if your answer is -$1,245,300.40 then enter-1,245,300

RET Inc. currently has one product, low-priced stoves. RET Inc.has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $30 million a year. Variable costs are 75% of sales.The project is expected to last 10 years. Also,non-variable costs are $4,000,000 per year. The company has spent $1,000,000 in research and a marketing study that determined the company will lose (cannibalization) $10 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $8 million a year.

The plant and equipment required for producing the new line of stoves costs $10,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $6,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $2,000,000 that will be returned at the end of the project.

The tax rate is 40 percent and the cost of capital is 10%.

1. What is the initial outlay (IO) for this project?

2. What is the annual Earnings before Interests, and Taxes(EBIT) for this project?

3. What is the annual net operating profits after taxes (NOPAT) for this project?

4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project?

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this project?Enter a negative # if it is a tax gain. For example, if your answer is a tax on capital gains of $3,004.80 then enter-3,005; if your answer is a tax shelter from a capital loss of $1,000,20 then enter1,000

7. What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project?

Question 2(4 points)

The two cardinal rules which financial analysts follow to avoid capital budgeting errors are: (1) capital budgeting decisions must be based on accounting income, and (2) only incremental cash flows are relevant to accept/reject decisions.

Question 2 options:

True

False

Question 3(4 points)

Which of the following statements is correct?

Question 3 options:

Sensitivity analysis is incomplete because it fails to consider the range of likely values of key variables as reflected in their probability distributions.

In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable, such as unit sales, would produce only a small error in the project's NPV.

The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done using a PC with a spreadsheet program or even a calculator.

Sensitivity analysis is a risk analysis technique that considers both the sensitivity of NPV to changes in key variables and the likely range of variable values.

Answers c and d are correct.

Question 4(4 points)

Which of the following statements is CORRECT?

Question 4 options:

Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.

Corporations must use the same depreciation method for both stockholder reporting and tax purposes.

Using accelerated depreciation rather than straight line normally has the effect ofspeedingup cash flows and thus increasing a project's forecasted NPV.

Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project.

Question 5(4 points)

Which of the following is not considered a relevant concern in determining incremental cash flows for a new product?

Question 5 options:

The use of factory floor space which is currently unused but is available for production of any product.

Revenues from the existing product that would be lost as a result of some customers switching to the new product.

Shipping and installation costs associated with preparing the machine to be used to produce the new product.

The cost of a product analysis completed in the previous tax year and specific to the new product.

None of the above (All are relevant concerns in estimating relevant cash flows attributable to a new product project.)

Question 6(4 points)

Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow?

Question 6 options:

erosion effects

taxes

fixed expenses

salaries

depreciation expense

Question 7(4 points)

The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following?

Question 7 options:

yearly incremental costs

sunk costs

opportunity costs

erosion cost

equivalent annual cost

Question 9(10 points)

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?

Question 9 options:

$11,220

$29,920

$43,480

$46,480

$46,620

Question 10(10 points)

Due to expected increases in sales, the Target Copy Company is contemplating purchasing a new printing machine costing $ 662 . To accomodate the new sales, the company will need to purchase additional inventory of $ 35 , part of which will be financed by an increase in accounts payable of $ 11 . Target's corporate tax rate is 32 percent. What is the initial after-tax outlay for the new printing machine? Since this is a cash outlay, be sure to use the - sign when writing your answer. Do not use the $ symbol.Your Answer:

Question 10 options:

Answer

Question 11(10 points)

McPherson Company must purchase a new milling machine. The purchase price is $50,000, including installation. The machine has a tax life of 5 years, and it can be depreciated according to the following rates. The firm expects to operate the machine for 4 years and then to sell it for $12,500. If the marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end of Year 4?

Year

Depreciation Rate

1

0.20

2

0.32

3

0.19

4

0.12

5

0.11

6

0.06

Question 11 options:

$8,878

$9,345

$10,355

$10,900

Question 12(10 points)

Colors and More is considering replacing the equipment it uses to produce crayons. The equipment would cost $1.37 million, have a 12-year life, and lower manufacturing costs by an estimated $310,000 a year. The equipment will be depreciated using straight-line depreciation to a book value of zero. The required rate of return is 15 percent and the tax rate is 35 percent. What is the net income from this proposed project?

Question 12 options:

$18,508.75

$40,211.24

$66,441.67

$127,291.67

$136,709.48

Question 13(10 points)

Sheridan Films is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, some new working capital would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV?

WACC

10.0%

Net investment in fixed assets (depreciable basis)

$70,000

Required new working capital

$10,000

Straight-line deprec. rate

33.333%

Sales revenues, each year

$75,000

Operating costs (excl. deprec.), each year

$30,000

Expected pretax salvage value

$5,000

Tax rate

35.0%

Question 13 options:

$20,762

$21,854

$23,005

$24,155