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Exam 14: Cash Flow Estimation and Capital Budgeting Decisions

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Question 21

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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%.The asset is expected to sell for $40,000 when the project terminates.Assume the asset class remains open when the asset is sold and the half-year rule applies in the first year.The firm's marginal tax rate is 40% and cost of capital is 8%.What impact would it have on the project's NPV if the cost of capital were 10%?

A) NPV decreases by 23.14%
B) NPV decreases by 38.04%
C) NPV decreases by 48.20%
D) NPV decreases by 61.41%

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Question 22

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According to the Canada Revenue Agency (CRA) : I.The purchase cost of a capital asset is to be capitalized and expensed as capital cost allowance over future periods. II.Any modification costs of a capital asset must 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.

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Question 23

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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.

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 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 should the company's image be classified within the context of this decision?

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 capital cost allowance. III.Increased expenditures on inventory for the new project. IV.Benefits that accrue to the local community.

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%.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%.The firm's marginal tax rate is 40%.What is the after-tax cash flow in year three, assuming half-year rule is applicable for CCA in year 1?

Explain how you would estimate the change in working capital in a firm by using financial statements.

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%.The asset is expected to sell for $40,000 when the project terminates.Assume the asset class remains open when the asset is sold and the accelerated investment incentive is applicable for CCA in year 1.The firm's marginal tax rate is 40% and cost of capital is 8%.What impact would it have on the project's NPV if the cost of capital were 10%?

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.

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.

Explain what externalities are and give an example.

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%.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%.The firm's marginal tax rate is 40%.What is the fourth year CCA expense assuming accelerated investment incentive is applicable for CCA in year 1?

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

You are given the following information on a project: $\bullet$ initial capital cost = $500,000 $\bullet$ installation costs associated with the capital asset = $25,000 $\bullet$ R&D costs already incurred = $50,000 $\bullet$ estimated salvage on equipment to be replaced = $80,000 $\bullet$ increase in raw materials inventory = $10,000 Which of these amounts is included with working capital?

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%, and an expected salvage value of $60,000 at the end of the 6^th year.The project has a beta of 1.5.The company's cost of capital is 12% and marginal tax rate is 35%.The risk-free rate is 4.5% and the market risk premium is 6%.Ignoring CCA, what is the present value of the after-tax operating cash flows?

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%.How much CCA would Canadian Donuts claim in year 3, assuming half-year rule is applicable for CCA in year 1?

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%.The firm's marginal tax rate is 40%.The firm's required rate of return is 8%.Assume the asset class remains open after the asset is sold.What is the present value of the CCA tax savings for the project assuming accelerated investment incentive is applicable for CCA in year 1?

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%.

You are given the following information on a project: $\bullet$ initial capital cost = $500,000 $\bullet$ installation costs associated with the capital asset = $25,000 $\bullet$ R&D costs already incurred = $50,000 $\bullet$ estimated salvage on equipment to be replaced = $80,000 $\bullet$ increase in raw materials inventory = $10,000 What is the initial cash outlay of the project?