Welcome to your ML301 Capital Budgeting

1. Which of the following items will lead to a rise in net working capital?
A. Raw materials are purchased prior to the sale of finished goods
B. The firm increases its cash balance
C. The firm makes a sale on credit
D. The firm buys inventory on credit
E. Short-term interest rates fall
2. A project will generate a real cash flow three years from now of $100,000. If the nominal discount rate is 10% and expected inflation is 3%, what is the nominal cash flow for year 3?
3. Paul earns $60,000 as an engineer, and he is considering quitting his job and going to graduate school. This $60,000 should be treated as a if Paul runs an NPV analysis of his graduate degree.
4. Fox Entertainment is evaluating the NPV of launching a new iPet product. Fox paid a market research firm $120,000 last year to test the market viability of iPet. Fox Entertainment should treat this $120,000 as a for the capital budgeting decision now confronting the firm.
Exhibit 9-2


The following data are projected for a possible investment project:

 

1

2

3

4

Revenues

$120,000

$140,000

$160,000

$180,000

Cost of Goods Sold

$ 36,000

$ 42,000

$ 48,000

$ 54,000

Depreciation

$ 80,000

$ 60,000

$ 40,000

$ 20,000

EBIT

 

NARREND

$    4,000

$ 38,000

$ 72,000

$106,000


5. Refer to Exhibit 9-2. The project requires an initial investment of $300,000. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period, and will be recaptured in full at the end of year The tax rate is 40%.

What is the initial cash outlay?
6. Refer to Exhibit 9-2. The project requires an initial investment of $300,000. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period, and will be recaptured in full at the end of year 4. The tax rate is 40%.

What is the net cash flow to the firm in year 1?

7. Refer to Exhibit 9-2. The project requires an initial investment of $300,000 on equipment. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period, and will be recovered in full at the end of year 4. Equipment will be sold at its book value at the end of year 4. The tax rate is 40%.What is the net cash flow to the firm in year 4?
8. Refer to Exhibit 9-2. The project requires an initial investment of $300,000 on equipment. Working capital is anticipated to be variable at 10% of revenues; the working capital investment must be made at the beginning of each period, and will be recovered in full at the end of year 4. Equipment will be sold at its book value at the end of year 4. The tax rate is 40%.What is the net present value of the project if the firm’s discount rate is 10%?
9. Future Semiconductor is considering the purchase of photolithography equipment that will cost $3 million. The equipment requires maintenance of $5,000 at the end of each of the next five years. After five years it will be sold for $500,000. Assume a cost of capital of 15% and no taxes. What is the present value of the cost of the equipment? What is the equivalent annual cost of the equipment?
10. Sam’s Insurance must choose between two types of printers. Both printers meet the firm’s quality standard. Printer A costs $3,500 and is expected to last 3 years with operating costs of $380 per year. Printer B costs $2,500 and is expected to last 2 years with operating costs of $400 per year. Assume a discount rate of 10%. Which printer should Sam’s Insurance purchase? What is the equivalent annual cost of this machine?
11. Arizona Truck Company (ATC) is considering the replacement of an old truck. The old truck can be sold for $7,800 now. If it is sold in one year, the resale price will be $5,500, but ATC will spend $2,500 just before selling the truck to make it attractive to a buyer. Assume a cost of capital of 12%. What is the total cost of keeping the old truck for one more year? Express the cash flow in terms of its future value one year from now.
12. A firm that manufactures DVD players for automakers currently has excess capacity. The firm expects that it will exhaust its excess capacity in three years. At that time it will have to invest $2 million to build new capacity. Suppose that the firm can accept additional work as a subcontractor for another company. By doing so, the firm will receive a net cash inflow of $120,000 immediately and in each of the next two years. However, the firm will have to begin expansion two years earlier than originally planned to bring new capacity on line. Assume a discount rate of 10%.What is the NPV if the firm accepts the subcontractor job?
13. A project generates the following sequence of cash flows over two years:

Year

Cash Flow ($ in millions)

0

-40.00

1

8.00

2

10.00

 

Assume that cash flows after the second year grow at 2% annually in perpetuity, and the discount rate is 12%. What is the NPV of the project?

14. Kelley Group is considering an investment of $2 million in an asset with an economic life of four years. The cash revenues and expenses in year 1 are expected to be $1.8m and $0.5m respectively. Both revenues and expenses are expected to grow at 3 percent per year. The asset will be fully depreciated to zero using the straight line method over its economic life. The salvage value of the asset is expected to be $0.3m at the end of the fourth year. Kelley Group also needs to add net working capital of $0.1m immediately, and this capital will be recovered in full at the end of the project’s life. The tax rate is 40%. What is the investment’s cash flow in year 4?
15. The value of a project at a given future point in time is known as:
16. The percentage of taxes owed on an incremental dollar of income is called:
17. Cash Flows that occur if and only if a project is accepted are:
18. Cash flows on an alternative investment that a firm decides not to make are a(n):
19. A cash outlay that has already been committed whether a project is accepted or not is known as a:
20. The difference between current assets and current liabilities is known as:
21. When a firm introduces a new product and some of the new product’s sales come at the expense of the firm’s existing products, this is known as:
22. Sunk costs:
23. Opportunity costs:
24. To help rank projects in a capital rationing environment, managers often use the:
25. The makes capital budgeting complicated.