Q1 Crane Potions, Inc., a pharmaceutical company, bought a machine at a cost of $2 million five
years ago that produces pain-reliever medicine. The machine has been depreciated over the past
five years, and the current book value is $854,000. The company decides to sell the machine now
at its market price of $1 million. The marginal tax rate is 25 percent.
What are the relevant cash flows?
Relevant cash flow
How do they change if the market price of the machine is $600,000 instead?
Relevant cash flow
Q2 Oriole Corporation just purchased computing equipment for $30,000. The equipment will be
depreciated using a five-year MACRS depreciation schedule. If the equipment is sold at the end
of its fourth year for $15,000, what are the after-tax proceeds from the sale, assuming the
marginal tax rate is 35 percent? (Round answer to 2 decimal places, e.g. 15.25.)
Q3 Cullumber, Inc., is considering opening up a new convenience store in downtown New York
City. The expected annual revenue at the new store is $770,000. To estimate the increase in
working capital, analysts estimate the ratio of cash and cash equivalents to revenue to be 0.03
and the ratios of receivables, inventories, and payables to revenue to be 0.05, 0.10, and 0.04,
respectively, in the same industry. What is the expected incremental cash flow related to working
capital when the store is opened?
Incremental cash flow
Q4 You are buying a sofa. You will pay $200 today and make three consecutive annual payments
of $300 in the future. The real rate of return is 16.5 percent, and the expected inflation rate is 4
percent. What is the actual price of the sofa? (Do not round factor values. Round final answer
to 2 decimal places, e.g. 15.25.)
Q5 Cullumber, Inc., is considering investing in a new production line for eye drops. Other than
investing in the equipment, the company needs to increase its cash and cash equivalents by
$10,000, increase the level of inventory by $42,000, increase accounts receivable by $25,000,
and increase accounts payable by $5,000 at the beginning of the project. Cullumber will recover
these changes in working capital at the end of the project 11 years later. Assume the appropriate
discount rate is 13 percent. What are the present values of the relevant investment cash
flows? (Do not round intermediate calculations. Round answer to 2 decimal places, e.g.
Q6 Given the soaring price of gasoline, Ford is considering introducing a new production line of
gas-electric hybrid sedans. The expected annual unit sales of the hybrid cars is 26,000; the price
is $21,000 per car. Variable costs of production are $11,000 per car. The fixed overhead
including salary of top executives is $80 million per year. However, the introduction of the
hybrid sedan will decrease Ford’s sales of regular sedans by 9,000 cars per year; the regular
sedans have a unit price of $20,000, a unit variable cost of $12,000, and fixed costs of $250,000
per year. Depreciation costs of the production plant are $49,000 per year. The marginal tax rate
is 40 percent. What is the incremental annual cash flow from operations?
Incremental annual cash flow from operations
Q7 Ivanhoe Company is considering buying a new farm that it plans to operate for 10 years. The
farm will require an initial investment of $12.15 million. This investment will consist of $2.85
million for land and $9.30 million for trucks and other equipment. The land, all trucks, and all
other equipment are expected to be sold at the end of 10 years for a price of $5.20 million, which
is $2.30 million above book value. The farm is expected to produce revenue of $2.05 million
each year, and annual cash flow from operations equals $1.95 million. The marginal tax rate is
35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this
investment. (Do not round factor values. Round final answer to 2 decimal places, e.g. 15.25.)
The project should be
Accepted or rejected
Q8 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.
ending cash flows
none of the above
Q 9In order to calculate free cash flow by starting with incremental cash flow from operations, we
subtract the incremental capital expenditures and add the incremental additions to working
add the incremental capital expenditures and the incremental additions to working capital.
subtract the incremental capital expenditures and the incremental additions to working capital.
none of the above.
Q10 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, then what overhead cost should the new division take into
account on its capital budgeting cash flow analysis?
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