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Exam 9: Fundamentals of Capital Budgeting

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Question 31

True/False

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The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.

A) True
B) False

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Question 32

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The EBIT break-even point can be calculated using which of the following formulas?

A) (Units Sold × Sale Price) + (Units Sold × Cost per unit) + SG&A - Depreciation = 0
B) (Units Sold × Sale Price) - (Units Sold × Cost per unit) + SG&A + Depreciation = 0
C) (Units Sold × Sale Price) + (Units Sold × Cost per unit) - SG&A - Depreciation = 0
D) (Units Sold × Sale Price) - (Units Sold × Cost per unit) - SG&A - Depreciation = 0

E) A) and C)
F) None of the above

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Question 33

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Use the figure for the question(s) below. -A consumer good company is developing a new brand of organic toothpaste. Above is the sensitivity analysis for this product. Which parameter should be scrutinised most carefully in the estimation process?

To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm's earnings.

CathFoods will release a new range of lollies which contain antioxidants. New equipment to manufacture the candy will cost $2 million, which will be depreciated by straight-line depreciation over five years. In addition, there will be $5 million spent on promoting the new line. It is expected that the range of lollies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year. If CathFood's marginal tax rate is 30%, what are the incremental free cash flows in the second year of this project?

Use the information for the question(s) below. The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year for each of the three years. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each. Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 30% tax bracket and has a cost of capital of 10%. -The change in net working capital from year 1 to year 2 is closest to:

Which of the following statements regarding real options is NOT correct?

Capital budgeting decisions use the Net Present Value rule so that those decisions maximise net present value (NPV).

A real option is the obligation to take a particular business action?

The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital.

How do we handle interest expense when making a capital budgeting decision?

What is the most important function of sensitivity analysis?

An oil company is buying a semi-submersible oil rig for $20 million. Additionally, it will cost $1.5 million to move the oil rig to the oil-field and to prepare it for operations. If it is depreciated over five years using straight-line depreciation, what are the yearly depreciation expenses in this case?

Use the information for the question(s) below. Epiphany Industries is considering a new capital budgeting project that will last for three years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projects: $\begin{array}{lrrr}\hline\text { Year }&0&1&2&3\\\hline \text { Sales (Revenues) } && 100,000 & 100,000 & 100,000 \\\hline \text { - Cost of Goods Sold (50\% of Sales) } && 50,000 & 50,000 & 50,000 \\\hline \text { - Depreciation } && 30,000 & 30,000 & 30,000 \\\hline \text { = EBIT } && 20,000 & 20,000 & 20,000 \\\hline \text { - Taxes }(30 \%) && 6000 & 6000 & 6000 \\\hline \text { = unlevered net income } && 14,000 & 14,000 & 14,000 \\\hline \text { + Depreciation } && 30,000 & 30,000 & 30,000 \\\hline+ \text { changes to working capital } && -5000 & -5000 & 10,000 \\\hline \text { - capital expenditures } & -90,000\\\hline\end{array}$ -The free cash flow for the first year of Epiphany's project is closest to?

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense?

A brewer is launching a new product-brewed ginger beer with a low alcohol content. The brewer plans to spend $4 million promoting this product this year, which is expected to expand its sales of this product to $10 million this year and $8 million next year. They do expect there will be loss of sales of $1 million this year and next year in their other products as customers switch to drinking the new ginger beer. The gross profit margin for the new ginger beer is 40%, the gross profit margin of all of the brewer's other products is 30%, and the brewer's marginal corporate tax rate is 30%. What are incremental earnings arising from the promotional campaign this year?

An insurance office owns a large building. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?

Cameron Industries is purchasing a new chemical vapour depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to raise gross profits by $4 million per year, starting at the end of the first year, with associated costs of $1 million for each of those years. The machine is expected to have a working life of six years and will be depreciated over those six years. The marginal tax rate is 30%. What are the incremental free cash flows associated with the new machine in year 1?

Which of the following best defines incremental earnings?

Which of the following is NOT a factor that a manager should bear in mind when estimating a project's revenues and costs?