Chapter 11 Cash Flows and Other Topics in Capital Budgeting

77) A company is expanding and has already signed a lease on new office space that costs $10,000 per month. The company also needs a new information system and hired a consultant to recommend new software. The consultant was paid $5,000 for her recommendation. Now the company is trying to make a choice between three competing software products. In the capital budgeting decision to purchase new software, the monthly rent for the office space is ________ and the consultant's fee is ________.

A) a sunk cost; a sunk cost

B) an opportunity cost; a sunk cost

C) incremental cash outflow; an opportunity cost

D) a sunk cost; a part of the initial outlay

78) As part of its expansion project, A.J. Industries Equipment Division has expanded its office space by 200 square feet. The company's administrative overhead is allocated based on the square footage of each business segment. Although the total administrative overhead for the company will remain the same, the Equipment Division will be charged more for administrative overhead. For the Equipment Division expansion project, the administrative overhead is an example of a(n)

A) incremental cash flow.

B) sunk cost.

C) opportunity cost.

D) incremental opportunity cash flow.

79) An asset with an original cost of $100,000 and a current book value of $20,000 is sold for $50,000 as part of a capital budgeting project. The company has a tax rate of 30%. This transaction will have what impact on the project's initial outlay?

A) reduce it by $20,000

B) reduce it by $50,000

C) reduce it by $6,000

D) reduce it by $15,000

80) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. AFB's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the incremental free cash flow during years 2 through 10 of the project?

A) $13,600

B) $14,400

C) $15,800

D) $16,400

81) AFB Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. AFB's marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project's ten-year life. What is the project's terminal cash flow?

A) $3,000

B) $5,000

C) $6,000

D) $8,000

82) Premium Pie Company needs to purchase a new baking oven to replace an older oven that requires too much energy to run. The industrial size oven will cost $1,200,000. The oven will be depreciated on a straight-line basis over its six-year useful life. The old oven cost the company $800,000 just four years ago. The old oven is being depreciated on a straight-line basis over its expected ten-year useful life. (That is, the old oven is expected to last six more years if it is not replaced now.) Due to changes in fuel costs, the old oven may only be sold today for $100,000. The new oven will allow the company to expand, increasing sales by $300,000 per year. Expenses will also decrease by $50,000 per year due to the more energy efficient design of the new oven. Premium Pie Company is in the 40% marginal tax bracket and has a required rate of return of 10%.

a. Calculate the net present value and internal rate of return of replacing the existing machine

b. Explain the impact on NPV of the following:

i. Required rate of return increases

ii. Operating costs of new machine are increased

iii. Existing machine sold for less

83) Agri-Industries purchased some agricultural land at the edge of a large metropolitan area for $250,000 five years ago. In order to have the land classified as agricultural for property tax purposes, the company has been leasing the property to neighboring farmers. The before-tax return from leasing the property is $12,000 per year. This company's corporate tax rate is 35 percent. If the company sells the land for $400,000 today, what is the internal rate of return on this investment?

84) Calculate the internal rate of return on the following projects:

a. Initial outlay of $60,500 with an after-tax cash flow of $11,897 per year for eight years.

b. Initial outlay of $647,000 with an after-tax cash flow of $118,000 per year for ten years.

c. Initial outlay of $25,400 with an after-tax cash flow $11,788 per year for three years.

85) Kelly Corporation is considering an investment proposal that requires an initial investment of $150,000 in equipment. Fully depreciated existing equipment may be disposed of for $40,000 pre-tax. The proposed project will have a five-year life, and is expected to produce additional revenue of $65,000 per year. Expenses other than depreciation will be $15,000 per year. The new equipment will be depreciated to zero over the five-year useful life, but it is expected to actually be sold for $20,000. Kelly has a 35% tax rate.

a. What is the net initial outlay for the proposed project?

b. What is the operating cash flow for years 1-4?

c. What is the total cash flow at the end of year five (operating cash flow for year 5 plus terminal cash flow)?

86) Dave Company, Inc. is considering purchasing a new grinding machine with a useful life of five years. The initial outlay for the machine is $165,000. The expected cash inflows are as follows:

Year	After-tax Expected Cash Flow
1	15,000
2	35,000
3	70,000
4	90,000
5	70,000

Given that the firm has a 10% required rate of return, what is the NPV?