Test Bank Chapter 11 Cash Flows And Capital Budgeting

Fundamentals of Corporate Finance, 5e (Parrino)

Chapter 11 Cash Flows and Capital Budgeting

1) The term incremental in the context of incremental after-tax free cash flows refers to the fact that the firm's total after-tax free cash flows will change if the new project is not adopted.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

2) Conceptually, free cash flows are what is left over for distribution to creditors and stockholders after the firm has made the necessary investments in working capital and long-term assets.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

3) Incremental cash flow from operations is the cash flow from a project that is expected to be generated after all operating expenses have been paid.

Learning Objective: LO 1

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

4) The purchase of a factory building is an example of an incremental addition to working capital.

Learning Objective: LO 1

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

5) If a firm expects to increase its investment in inventory due to a prospective project, then this is an example of an incremental capital expenditure.

Learning Objective: LO 1

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

6) The stand-alone principle says that we can treat a project as if it were a stand-alone firm that has its own revenue, expenses, and investment requirements.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

7) If you add depreciation and amortization to incremental net operating profits after tax (NOPAT), then you will obtain incremental cash flow from operations.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

8) Free cash flow equals cash flow from operations minus required investments.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

9) Increases in working capital are considered cash flows associated with short term investments.

Learning Objective: LO 3

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

10) Accounting earnings are a reliable measure of the costs and benefits of a project.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

11) If taken without accompanying changes in cash flow, changes in a company's accounting earnings do not affect the overall value of the firm.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

12) Allocated costs such as corporate overhead should be included in free cash flow calculations.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

13) The impact of a project on another project's free cash flows should be ignored.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

14) Opportunity costs should always be included in a project's projected free cash flow.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

15) The research and development costs to date of a project should be considered when analyzing the cash flows of a prospective project.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

16) Since our perspective when evaluating a project is that of all of the investors in the firm, creditors as well as stockholders, then we should use the pretax cash flows produced by the project.

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

17) Since our perspective when evaluating a project is that of the shareholders only, then we should use the after-tax cash flows produced by a project.

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

18) BioGeological Pharmaceuticals invested $100 million on a heart drug that does not prevent heart disease. BioGeological has since found that the drug does prevent diabetes. When considering whether to market the drug as a diabetic panacea, the firm should include the $100 million spent while investigating the heart-related effects.

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

19) When analyzing a project, if the expected future cash flows are denominated in nominal dollars, then the discount rate should represent a nominal rate as well.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

20) Nominal interest rates do not incorporate the expected rate of inflation.

Learning Objective: LO 2

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

21) If the current market price of corn is $100 per bushel and the nominal rate of interest is 10 percent, then the nominal price of corn next period should also be $100.

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

22) A progressive tax system means that a taxpayer will pay a higher tax rate for a given dollar of earnings for every successive year.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

23) It is possible for a firm to have one depreciation schedule for tax purposes and another for financial reporting purposes.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

24) The MACRS depreciation tax schedule for three-year equipment provides a depreciation rate for a total of three years.

Learning Objective: LO 2

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

25) Terminal-year free cash flows may differ from the cash flows provided in the typical year of a project for reasons such as the return/repayment of increases/reductions in additional working capital in the prior years.

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

26) If the salvage value is less than the book value of the asset at the time of an asset disposition, then the firm will effectively receive a positive cash flow from taxes on the sale.

Learning Objective: LO 2

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

27) The expected cash flows for a project are fixed amounts that have zero variability in the projected values.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

28) The unadjusted NPVs of two projects with different useful lives can be compared to determine which project is the better of the two.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

29) When forecasting operating expenses, analysts distinguish between fixed costs which vary with sales and variable costs which do not.

Learning Objective: LO 3

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

30) You own a uranium mine and the price of uranium is expected to increase at a rate of 3 percent per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not to begin harvesting the element. The correct choice is to begin harvesting immediately if the current NPV of the project is positive.

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

31) You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not to begin harvesting the element. The correct choice is to begin harvesting immediately under all circumstances.

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

32) The cash flows used in capital budgeting calculations are based on:

A) historical estimates.

B) forecasts of future cash revenues, expenses, and investment outlays.

C) forecasts of net income.

D) forecasts of retained earnings available for financing projects.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

33) The NPV of a project includes discounting:

A) the expected cash flows of a project in the future.

B) only the certain cash flows of a project in the future.

C) the variance of the expected cash flows of a project in the future.

D) the initial cash outflow.

Learning Objective: LO 2

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

34) The ________ is intended to reconcile changes in the balance sheet cash accounts.

A) capital budgeting cash flow calculation

B) accounting statement of cash flows

C) accounting statement of income

D) accounting statement of changes in equity

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

35) The term ________ refers to the fact that these cash flows reflect the amount by which the firm's total after-tax free cash flows will change if the project is adopted.

A) periodic

B) ending cash flows

C) incremental

D) discounted

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

36) ________ refers to the cash flow that a project is expected to generate after all operating expenses and taxes have been paid.

A) Incremental cash flow from operations

B) Operating income

C) EBITDA

D) Net income

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

37) In order to calculate free cash flow by starting with incremental cash flow from operations, we should:

A) subtract the incremental capital expenditures and add the incremental additions to working capital.

B) add the incremental capital expenditures and the incremental additions to working capital.

C) subtract the incremental capital expenditures and the incremental additions to working capital.

D) add the incremental capital expenditures and subtract the incremental additions to working capital.

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

38) The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as the:

A) stand-alone principle.

B) dependent principle.

C) independent principle.

D) cash flow principle.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

39) The firm's ________ is used to calculate NOPAT because the profits from a project are assumed to be incremental to the firm.

A) average tax rate

B) marginal tax rate

C) lowest marginal tax rate

D) highest marginal tax rate

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

40) Additions to tangible assets, intangible assets, and current assets can be described as:

A) cash flows associated with investments.

B) operating cash flows.

C) free cash flows.

D) cash flows associated with financing.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

41) The impact of a project on a firm's overall value depends on a:

A) firm's accounting earnings.

B) firm's cash flows.

C) project's cash flows.

D) project's duration.

Learning Objective: LO 1

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

42) Which of the following should NOT be included in a project's cash flows calculations?

A) Cash expenses

B) Cash revenues

C) Allocated expenses

D) Changes in working capital

Learning Objective: LO 2

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

43) In project analysis, corporate overhead allocations should only be taken into account if the:

A) firm is currently covering all of its overhead allocations.

B) firm is currently unable to cover all of its overhead allocations.

C) overhead allocations involve cash expenditures.

D) overhead allocations do not involve cash expenditures.

Learning Objective: LO 2

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

44) Brown Mack, Inc., currently has two large manufacturing divisions that share a single plant. Brown Mack owns the plant but has calculated that $6 million of overhead expenses should be allocated to the two equal-sized divisions. If Brown Mack starts a third manufacturing division, of equal size to the other two divisions, what overhead cost should the new division take into account on its capital budgeting cash flow analysis?

A) $0

B) $2 million

C) $3 million

D) $6 million

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

45) A firm is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. The project would also reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?

A) $2.4 million

B) $3.4 million

C) $4.6 million

D) $5.0 million

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

46) Whenever a project has a negative impact on an existing project's cash flows, then that effect should:

A) be ignored.

B) be ignored if the project is evaluated using the correct cost of capital.

C) be included as a negative revenue amount on the new project's cash flow analysis.

D) be included if the impact is limited to noncash expenditures.

Learning Objective: LO 2

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

47) If Company X has the option of leasing some factory space to Company Y or utilizing it for another product line, how should Company X handle the lost lease payments on the factory space if it chooses the product line?

A) Ignore it.

B) Include it as an opportunity cost.

C) Include half of it as additional revenue for the project.

D) Include all of it as additional revenue for the project.

Learning Objective: LO 2

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

48) Which of the following is the best example of a sunk cost?

A) Future payments on a leased building

B) Future research and development costs

C) Historical research and development costs

D) Historical noncash expenses

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

49) ________ represent dollars stated in terms of constant purchasing power.

A) Nominal dollars

B) Real dollars

C) Inflated dollars

D) Constant dollars

Learning Objective: LO 2

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

50) If inflation is anticipated to be 10 percent during the next year while a nominal rate of 20 percent will be earned on U.S. Treasury bills, what is the accurate real rate of return on these securities? (Round final percentage answer to decimal places.)

A) 20.05%

B) 10.01%

C) 9.09%

D) 20.0%

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

51) If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation is 8 percent, then what should nominal rate of return be? (Round final percentage answer to decimal places.)

A) 14.05%

B) 33.05%

C) 23.12%

D) 5.55%

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

52) If you are discounting a project's cash flows using the nominal cost of capital, then that means that you have taken the ________ into account.

A) real rate of return

B) expected rate of inflation

C) real rate of return and the expected rate of inflation

D) real rate of return or the expected rate of inflation

Learning Objective: LO 2

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

53) A tax system in which taxpayers pay a progressively larger share of their income in taxes as their income rises is called:

A) a flat tax system.

B) a progressive tax system.

C) a digressive tax system.

D) a political tax system.

Learning Objective: LO 2

Bloomcode: Knowledge

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

54) For a U.S. C-corporation with a flat federal tax, the average federal tax rate is:

A) less than the marginal tax rate.

B) equal to the marginal tax rate.

C) greater than the marginal tax rate.

D) either less than or greater than the marginal tax rate.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

55) When compared to the straight-line depreciation method, MACRS has:

A) a greater proportion of its depreciation early in the life of the asset.

B) a lesser proportion of its depreciation early in the life of the asset.

C) an equal proportion of its depreciation early in the life of the asset.

D) either a greater or lesser proportion of its depreciation early in the life of the asset.

Learning Objective: LO 4

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

56) In order for a project to generate a positive net working capital cash flow at the end of its useful life, the project:

A) must have generated a cumulative negative cash flow during the life of the project.

B) must have generated a cumulative positive cash flow during the life of the project.

C) must have generated a cumulative negative cash flow at the conclusion of the project.

D) could not have generated a positive cash flow at the opening of the project.

Learning Objective: LO 4

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

57) When deciding to select one project or another where the projects have different useful lives, you could utilize:

A) a repeated investment analysis to decide which project is better for the firm.

B) a net present value analysis to compare each project without adjusting for the different useful lives of the projects because it is not applicable.

C) payback period calculations to make a decision.

D) an internal rate of return analysis which is preferred over an equivalent annual annuity analysis.

Learning Objective: LO 4

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

58) Windy Burgers is trying to determine when to harvest a herd of cows that it currently owns. If it harvests the herd in year 1, the NPV of the project would increase over an immediate harvest by 25 percent. A year 2 harvest would create an NPV increase of 15 percent over that of year 1 and year 3 would create an NPV increase of 7 percent over that of year 2. If the cost of capital is 12 percent for Windy, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.

A) Harvest immediately.

B) Harvest in year 1.

C) Harvest in year 2.

D) Harvest in year 3.

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

59) Stillwater Drinks is trying to determine when to harvest the water from the fountain of youth that it currently owns. If it harvests the water in year 1, the NPV of the project would increase over an immediate harvest by 18 percent. A year 2 harvest would create an NPV increase of 12 percent over that of year 1 and year 3 would create an NPV increase of 8 percent over that of year 2. If the cost of capital is 17 percent for Stillwater, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.

A) Harvest immediately.

B) Harvest in year 1.

C) Harvest in year 2.

D) Harvest in year 3.

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

60) The proper time to harvest an asset is when the percentage NPV increase of harvesting a project at a future point in time is at the last date where the increase is:

A) greater than the cost of capital.

B) less than the cost of capital.

C) 10 percent greater than the cost of capital.

D) equal to the cost of capital.

Learning Objective: LO 5

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

61) Norman, Inc., is considering two mutually exclusive projects. Project A is a six-year project with a NPV of $3,000 and Project B is a four-year project with an NPV of $2,278. Project A has an equivalent annual cash flow of $730 and Project B has an equivalent annual cash flow of $750. Which project should the firm select?

A) Choose Project A because it has the higher NPV.

B) Choose Project B because it has the lower NPV.

C) Choose Project B because it has the higher equivalent annual cash flow.

D) Choose Project A because it has the lower equivalent annual cash flow.

Learning Objective: LO 4

Bloomcode: Analysis

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

Reference 11-1 Use the following to answer the questions below:

Provo, Inc., had revenues of $10 million, cash operating expenses of $5 million, and depreciation and amortization of $1 million during 2020. The firm purchased $500,000 of equipment during the year while increasing its inventory by $300,000 (with no corresponding increase in current liabilities). The marginal tax rate for Provo is 40 percent.

62) Refer to Reference 11-1. Free cash flow: What is Provo's cash flow from operations for 2020?

A) $2,400,000

B) $2,600,000

C) $3,400,000

D) $4,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

63) Refer to Reference 11-1. Free cash flow: What is Provo's free cash flow for 2020?

A) $2,400,000

B) $2,600,000

C) $3,400,000

D) $4,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

64) Refer to Reference 11-1. Free cash flow: What is Provo's NOPAT for 2020?

A) $2,400,000

B) $2,600,000

C) $3,400,000

D) $4,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

65) Refer to Reference 11-1. Free cash flow: What is Provo's cash flows associated with investments for 2020?

A) $300,000

B) $500,000

C) $800,000

D) $1,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

Reference 11-2 Use the following to answer the questions below:

Champagne, Inc., had revenues of $12 million, cash operating expenses of $8 million, and depreciation and amortization of $1.5 million during 2020. The firm purchased $700,000 of equipment during the year while increasing its inventory by $500,000 (with no corresponding increase in current liabilities). The marginal tax rate for Champagne is 30 percent.

66) Refer to Reference 11-2. Free cash flow: What is Champagne's cash flow from operations for 2020?

A) $2,050,000

B) $2,500,000

C) $3,250,000

D) $4,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

67) Refer to Reference 11-2. Free cash flow: What is Champagne's free cash flow for 2020?

A) $2,050,000

B) $2,500,000

C) $3,250,000

D) $4,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

68) Refer to Reference 11-2. Free cash flow: What is Champagne's NOPAT for 2020?

A) $1,750,000

B) $2,500,000

C) $3,250,000

D) $4,000,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

69) Refer to Reference 11-2. Free cash flow: What are Champagne's cash flows associated with investments for 2020?

A) $500,000

B) $700,000

C) $1,200,000

D) $1,700,000

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

70) Marginal and average tax rates: Use the tax rate taken from the table below to calculate the total taxes paid for Lansing, Inc., this year. Lansing's pretax income was $275,000.

U.S. Corporate Tax Rate Schedule in 2019

Taxable Income

More But Not

Than More Than Tax Owed

$0 $50,000 15% of amount beyond $0

$50,000 $75,000 $7,500 + 25% of amount beyond $50,000

$75,000 $100,000 $13,750 + 34% of amount beyond $75,000

$100,000 $335,000 $22,250 + 39% of amount beyond $100,000

$335,000 $10,000,000 $113,900 + 34% of amount beyond $335,000

$10,000,000 $15,000,000 $3,400,000 + 35% of amount beyond $10,000,000

$15,000,000 $18,333,333 $5,150,000 + 38% of amount beyond $15,000,000

$18,333,333 ------- 35% on all income

A) $22,500

B) $68,250

C) $90,500

D) $107,250

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

71) Marginal and average tax rates: Use the tax rate taken from below to calculate the average tax rate for Lansing, Inc., this year. Lansing's pretax income was $275,000.

(Round final answer to nearest whole percent.)

U.S. Corporate Tax Rate Schedule in 2019

Taxable Income

More But Not

Than More Than Tax Owed

$0 $50,000 15% of amount beyond $0

$50,000 $75,000 $7,500 + 25% of amount beyond $50,000

$75,000 $100,000 $13,750 + 34% of amount beyond $75,000

$100,000 $335,000 $22,250 + 39% of amount beyond $100,000

$335,000 $10,000,000 $113,900 + 34% of amount beyond $335,000

$10,000,000 $15,000,000 $3,400,000 + 35% of amount beyond $10,000,000

$15,000,000 $18,333,333 $5,150,000 + 38% of amount beyond $15,000,000

$18,333,333 ------- 35% on all income

A) 8.0%

B) 25.0%

C) 32.9%

D) 39.0%

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

72) Computing the terminal-year FCF: Miles Cyprus Corp. purchased a truck that currently has a book value of $1,000. If the firm sells the truck for $5,000 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 30 percent marginal tax rate?

A) $1,200

B) $3,800

C) $4,000

D) $5,000

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

73) Computing the terminal-year FCF: Babaloo Nightclubs purchased a disco mirror that currently has a book value of $10,000. If Babaloo sells the disco mirror for $500 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 39 percent marginal tax rate?

A) $500

B) $3,705

C) $4,205

D) $9,500

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

74) Expected cash flows: Fire Rock Wheel Corp is evaluating a project in which there is a 40 percent probability of revenues totaling $3 million and a 60 percent probability of revenues totaling $1 million per year. Its cash expenses will be $1.0 million while depreciation expense will be $200,000; then what is the expected free cash flow from taking the project if the marginal tax rate for the firm is 30 percent?

A) $200,000

B) $420,000

C) $600,000

D) $620,000

Learning Objective: LO 2

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

75) Projects with different lives: Your firm is deciding whether to purchase a durable delivery vehicle or a short-term vehicle. The durable vehicle costs $25,000 and should last five years. The short-term vehicle costs $10,000 and should last two years. If the cost of capital for the firm is 15 percent, then what is the equivalent annual cost for the best choice for the firm? (Round final answer to nearest whole dollar.)

A) $5,000, either vehicle

B) $5,000, short-term vehicle

C) $6,151, short-term vehicle

D) $7,458, long-term vehicle

Learning Objective: LO 4

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

76) Projects with different lives: Your firm is deciding whether to purchase a high-quality printer for your office or one of lesser quality. The high-quality printer costs $40,000 and should last four years. The lesser quality printer costs $30,000 and should last three years. If the cost of capital for the firm is 13 percent, then what is the equivalent annual cost for the best choice for the firm? Round to the nearest dollar.

A) $10,000, either printer

B) $10,000, lesser quality printer

C) $12,706, lesser quality printer

D) $13,448, high-quality printer

Learning Objective: LO 4

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

77) When to harvest an asset: Cleveland Millicrum is considering when to harvest its moldy bread supply for antibiotics. It has calculated that the current NPV dollars for harvesting the bread are increasing according to the following schedule. When should the firm harvest the bread? The cost of capital for the firm is 14 percent.

NPV increase if harvested next year over that of harvesting now is 25%

NPV increase if harvested year 2 over that of harvesting year 1 is 20%

NPV increase if harvested year 3 over that of harvesting year 2 is 17%

NPV increase if harvested year 4 over that of harvesting year 3 is 13%

NPV increase if harvested year 5 over that of harvesting year 4 is 10%

A) Harvest now

B) Harvest year 2

C) Harvest year 3

D) Harvest year 4

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

78) When to harvest an asset: Farmer Ag owns a special species of cotton-producing plant that, if left unharvested, grows a bigger bowl of cotton through time. The NPV, at the beginning of the year that harvesting takes place, is as follows. When should Farmer Ag harvest its cotton? Assume a discount rate of 14 percent.

NPV1 = $50,000

NPV2 = $60,000

NPV3 = $69,000

NPV4 = $77,280

NPV5 = $85,008

A) Harvest now

B) Harvest in year 1

C) Harvest in year 2

D) Harvest in year 3

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

79) When to replace an asset: Nemo Haulers is considering whether to purchase a new mini tractor for moving furniture within its warehouse. Nemo calculates that its current mini tractor generates $3,100 of cash flow per year. A new mini tractor would cost $3,000 and would provide cash flow of $4,000 per year for five years. What is the equivalent annual cash flow for the new mini tractor (round to the nearest dollar), and should Nemo purchase the new tractor? Assume the cost of capital for Nemo is 10 percent.

A) $3,000, do not purchase the new tractor

B) $3,209, purchase the new tractor

C) $4,000, purchase the new tractor

D) $12,163, purchase the new tractor

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

80) When to replace an asset: Burt's Pizzas is considering whether to purchase an oven. Burt's calculates that its current oven generates $4,000 of cash flow per year. A new oven would cost $15,000 and would provide cash flow of $6,000 per year for six years. What is the equivalent annual cash flow for the new oven (round to the nearest dollar), and should Burt's purchase the new oven? Assume the cost of capital for Burt's is 12 percent.

A) $2,352, do not purchase the oven

B) $6,000, purchase the oven

C) $9,668, purchase the oven

D) $24,668, purchase the oven

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

81) The cost of using an existing asset: Small Appliances, Inc., is considering starting a new line of business with the excess capacity it currently has on its rivet machine. The current machine is expected to last four years at the current rate of production. However, if a new line of business is taken on, then the machine will have to be replaced in three years instead of four. A new machine that will last four years would cost $50,000. What is the cost of taking on the new line of business? Round to the nearest dollar and assume a 9 percent cost of capital.

A) $11,917

B) $12,500

C) $15,433

D) $50,000

Learning Objective: LO 5

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

82) Which of the following statements is correct?

A) Incremental net operating profits after-tax should include sunk costs associated with a project.

B) Incremental net operating profits after-tax should include the effects of financing costs associated with a project.

C) Incremental net operating profits after-tax should exclude the effects of depreciation costs associated with a project.

D) Incremental net operating profits after-tax should exclude the effects of financing costs associated with a project.

Learning Objective: LO 1

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

83) Which of the following statements is true?

A) The calculation of free cash flow does not include the impact of income taxes.

B) Accounting earnings are an unreliable measure of the costs and benefits of a project.

C) The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as the incremental principle.

D) Depreciation expense should not be included in the calculation of incremental net operating profits after-tax.

Learning Objective: LO 1

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

84) General Mills is undertaking an analysis on a new cereal. The firm realizes that if they come out with a new product, it would affect sales of existing products. What is the best course of action for General Mills in this analysis?

A) Treat the reduction of sales from existing cereals as a sunk cost.

B) Account for the reduction of sales from existing cereals in the projection of cash flows on the new product.

C) Include the allocated costs of the new cereal in the sales of the pre-existing products.

D) Ignore the fact that sales of other products will be affected.

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

85) Operating Cash Flow: Premier Steel, Inc. is considering the purchase of a new machine for $100,000 that has a useful life of 3 years. The firm's cost of capital is 11.0 percent and the tax rate is 40 percent. This machine will be sold for its salvage value of $20,000 at the end of 3 years. The machine will require an investment of $2,500 in spare parts inventory upon installation. The machine will cost $8,000 to ship and $4,000 to install and modify it.

Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in working capital will be liquidated at termination of the project at the end of year 3.

MACRS Rates 33% 45% 15% 7%

Using MACRS, what is the operating cash flow in year 1?

A) $53,784

B) $35,238

C) $86,999

D) $42,512

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

86) Average versus Marginal Tax Rate: Suppose Franklin Corporation had pretax income of $300,000 in 2020 and that the firm would have paid $100,250.00 in federal income taxes. What is Franklin's average income tax rate? (Round to the nearest 0.1%.)

A) 39.0%

B) 34.7%

C) 33.4%

D) 38.6%

Learning Objective: LO 2

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

87) Which of the following should NOT be included in a schedule of cash flows from operations when evaluating a capital project?

A) Fixed costs

B) Sunk costs

C) Depreciation and amortization

D) Variable costs

Learning Objective: LO 3

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

88) Which of the following is an example of a fixed cost?

A) Cost of equipment purchased for an assembly line to be used in the production of a new product

B) Assembly costs associated with the production of a new product

C) Labor costs associated with the production of a new product

D) Shipping costs associated with the sale of a new product

Learning Objective: LO 3

Bloomcode: Comprehension

AACSB: Analytic

IMA: Business Economics

AICPA: Industry/Sector Perspective

89) Your firm is evaluating the merits of several different machines. Machine A has a useful life of 5 years, generates an NPV of $53,250, an IRR of 13.6 percent and an equivalent annual cost of $10,316. Machine B has a useful life of 3 years, an NPV of $61,051, an IRR of 12.5 percent, and an equivalent annual cost of $9,724. Machine C has a useful life of 4 years, generates an NPV of $55,225, an IRR of 15.2 percent and an equivalent annual cost of $7,535 Machine D has a useful life of 7 years, generates an NPV of $64,020, an IRR of 11.4 percent and an equivalent annual cost of $8,885.

Which machine should be purchased and why?

A) Machine C, because it has the highest IRR

B) Machine D, because it has the highest NPV

C) Machine A, because it has the most positive EAC

D) Machine B, because it has the shortest useful life

Learning Objective: LO 4

Bloomcode: Evaluation

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

90) Equivalent Annual Cost: Your firm is considering an investment that will cost $750,000 today. The investment will produce cash flows of $250,000 in year 1, $400,000 in year 2, and $600,000 in year 3. The discount rate that your firm uses for projects of this type is 11.75 percent.

What is the investment's equivalent annual cost? (Round to the nearest whole dollar.)

A) $163,613

B) $225,008

C) $68,888

D) $92,845

Learning Objective: LO 4

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

91) When is the appropriate time to harvest an asset?

A) That point in time where harvesting the asset yields the largest internal rate of return

B) That point in time where harvesting the asset yields the smallest payback

C) That point in time where harvesting the asset yields the largest accounting rate of return

D) That point in time where harvesting the asset yields the largest net present value

Learning Objective: LO 5

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

92) Briefly explain the two methods of comparing projects with different useful lives.

Learning Objective: LO 4

Bloomcode: Application

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

93) Explain why in practice the cash flows associated with a project are not certain cash flows.

Learning Objective: LO 2

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

94) Why is depreciation and amortization added back when calculating free cash flows generated by a project?

Learning Objective: LO 1

Bloomcode: Comprehension

AACSB: Analytic

IMA: Investment Decisions

AICPA: Industry/Sector Perspective

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