QUESTION 5. (25 MARKS)

A. (15 marks)

1. Peter is considering the purchase of one of two machines used in his industrial plant. Machine P has a life of two years, costs $50 initially, and then $65 per year in maintenance costs. Machine Q has a life of 3 years, costs $80 initially, and requires $45 in annual maintenance costs. Either machine must be replaced at the end of its life. Which is the better machine for the firm? Explain. The discount rate is 14% and the tax rate is zero. (4 marks) 2. A new tablet project for the WOO company has the following data. The estimated sales price of the new tablet is $400 and sales volume to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. The project has a three-year life. Variable costs amount to $225 per unit and fixed costs are $120,000 per year. The project requires an initial investment of $185,000, which is depreciated straight-line to zero over the three-year project life. The actual market value of the initial investment at the end of year 3 is $45,000. Initial net working capital investment is $60,000 and NWC will maintain a level equal to 15% of sales each year thereafter. The tax rate is 34% and the required return on the project is 12%. Given the $60,000 initial investment in NWC, what change occurs for NWC during year 1? Explain. (4 marks)

3. BBB Inc. is considering a 3-year project with an initial cost of $745,000. The project will not directly produce any sales but will reduce operating costs by $205,000 a year. The equipment is depreciated straight-line to a zero book value over the life of the project. At the end of the project the equipment will be sold for an estimated $35,000. The tax rate is 34%. The project will require $31,000 in extra inventory for spare parts and accessories. Calculate the NPV. Should this project be implemented if BBB requires an 8% rate of return? Why or why not? (4 marks) 4. New equipment costs $790,000 and is expected to last for five years with no salvage value. During this time the company will use a 30% CCA rate. The new equipment will save $160,000 annually before taxes. If the company's required rate of return is 12%, determine the PVCCATS of the purchase. Assume the half-year rule applies and a tax rate of 35%. (3 marks)

B. (10 marks). Please choose one of the four answers (1 mark for each):

1. A cost that has already been paid, or the liability to pay has already been incurred, is a(n):

A. Salvage value expense

B. Net working capital expense

C. Sunk cost

D. Opportunity cost

2. The changes in the firm's future cash flows that are a direct consequence of accepting a project are called:

A. Net present value cash flows

B. Incremental cash flows

C. Stand-alone cash flows

D. After-tax cash flows

3. The result of Capital Cost Allowance multiplied by marginal corporate tax rate is called:

A. total tax cost

B. corporate income tax

C. the capital cost allowance tax shield

D. none of the above

4. 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. II and IV only

C. I, II, and III only

D. II, III, and IV only

5. Changes in the net working capital requirements:

A. can affect the cash flows of a project every year of the project's life

B. only affect the initial cash flows of a project

C. only affect the cash flow at time zero and the final year of a project

D. are generally excluded from project analysis due to their irrelevance to the total project

6. Which one of the following is a project cash inflow? Ignore any tax effects.

A. decrease in accounts payable

B. decrease in accounts receivable

C. increase in inventory

D. depreciation expense based on the straight-line method

7. The cash flows of a new project that come at the expense of a firm's existing projects are:

A. Side effects or Externalities costs.

B. Salvage value expenses.

C. Net working capital expenses.

D. Sunk costs.

8. 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. earnings before interest and taxes plus depreciation

B. earnings before interest and taxes minus taxes

C. net income plus depreciation

D. (sales minus costs) times (1-depreciation) times (1-tax rate)

9. In Canada, the deductions of capital cost allowance have:

A. negative impact on the firm's cash flows

B. no impact on the firm's cash flows

C. positive impact on the firm's cash flows

D. none of the above

10. The capital cost allowance tax shield is nothing more than a growing perpetuity with a growth rate equal to:

A. a positive percentage

B. a negative percentage

C. zero

D. none of the above