Ch 8 Pearson HW Questions PDF

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FINC 5300 Chapter 8 HW Questions 1. Which of the following statements is FALSE? A. When sales of a new product displace sales of an existing product, the situation is often referred to as cannibalization. B. Income Tax = EBIT × (1 − τc). C. A capital budget lists the projects and investments that a company plans to undertake during the coming year. D. Overhead expenses are often allocated to the different business activities for accounting purposes. 2. Which of the following statements is FALSE? A. With straight−line depreciation the asset's cost is divided equally over its life. B. Sales will ultimately decline as the product nears obsolescence or faces increased competition. C. Managers sometimes continue to invest in a project that has a negative NPV because they have already invested a large amount in the project and feel that by not continuing it, the prior investment will be wasted. D. A project's unlevered net income is equal to its incremental revenues less costs and depreciation, evaluated on a pre−tax basis. 3. Which of the following statements is FALSE? A. We begin the capital budgeting process by determining the incremental earnings of a project. B. Investments in plant, property, and equipment are directly listed as expenses when calculating earnings. C. The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre−tax income. D. The opportunity cost of using a resource is the value it could have provided in its best alternative use. 4. Which of the following statements is FALSE? A. To determine the capital budget, firms analyze alternative projects and decide which ones to accept through a process called capital budgeting. B. When evaluating a capital budgeting decision, the correct tax rate to use is the firm's average corporate tax rate. C. A new product typically has lower sales initially, as customers gradually become aware of the product. D. Sunk costs have been or will be paid regardless of the decision whether or not to proceed with the project. 5. Which of the following statements is FALSE? A. Sunk costs are incremental with respect to the current decision regarding the project and should be included in its analysis. B. Overhead expenses are associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the corporation. C. When computing the incremental earnings of an investment decision, we should include all changes between the firm's earnings with the project versus without the project. D. Because value is lost when a resource is used by another project, we should include the opportunity cost as an incremental cost of the project. 6. Which of the following statements is FALSE? A. Unlevered Net Income = (Revenue − Costs − Depreciation) × (1 − τc). B. Earnings are not cash flows. C. The ultimate goal in capital budgeting is to determine the effect on the firm's cash flows of the decision to take a particular project.. D. To the extent that overhead costs are fixed and will be incurred in any case, they are incremental to the project and should be included in the capital budgeting analysis 7. Which of the following statements is FALSE? A. Any money that has already been spent is a sunk cost and therefore irrelevant in the capital budgeting process. B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C. Project externalities are direct effects of the project that may increase or decrease the profits of the business activities of other firms. D. The average selling price of a product and its cost of production will generally change over time.

8. Which of the following statements is FALSE? A. As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings. B. When evaluating a capital budgeting decision, we generally include interest expense. C. Many projects use a resource that the company already owns. D. Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project.

Projec t A B

Year 0 Cash Flow −100 −73

Use the table for question(s) 9 and 10 below. Consider the following two projects: Year 4 Year 3 Year 2 Year 1 Cash Cash Cash Cash Flow Flow Flow Flow 40 50 60 N/A 30 30 30 30

Discount Rate .15 .15

9. Which of the following statements is FALSE? A. Unlevered Net Income = EBIT × τc. B. The decision to continue or abandon a project should be based only on the incremental costs and benefits of the project going forward. C. A simple method often used to calculate depreciation is the straight−line method. D. A sunk cost is any unrecoverable cost for which the firm is already liable. 10. Which of the following costs would you consider when making a capital budgeting decision? A. Fixed overhead cost B. Sunk cost C. Opportunity cost D. Interest expense 11. A decrease in the sales of a current project because of the launching of a new project is called: A. an irrelevant aspect of the investment decision. B. cannibalization. C. a sunk cost. D. an overhead expense. 12. Money that has been or will be paid regardless of the decision whether or not to proceed with the project is: A. a sunk cost. B. an opportunity cost. C. cannibalization. D. considered as part of the initial investment in the project. 13. The value of currently unused warehouse space that will be used as part of a new capital budgeting project is: A. irrelevant to the investment decision. B. an overhead expense. C. a sunk cost. D. an opportunity cost. Use the following information to answer question(s) 14 and 15 below. Ford Motor Company is considering launching a new line of Plug−in Electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $35 million next year. Without the new SUV, Ford expects to earn pre−tax income of $80 million from operations next year. Ford pays a21% tax rate on its pre−tax income.

14. The amount that Ford Motor Company will owe in taxes next year without the launch of the new SUV is closest to: A. $31.5 million. B. $56.0 million. C. $16.8 million. D. $9.45 million.

15. The amount that Ford Motor Company will owe in taxes next year with the launch of the new SUV is closest to: A. $56.0 million. B. $31.5 million. C. $24.0 million. D. $9.45 million. Use the following information to answer question(s) 16 below. Food For Less (FFL), a grocery store, is considering offering one hour photo developing in their store. The firm expects that sales from the new one−hour machine will be $150,000 per year. FFL currently offers overnight film processing with annual sales of $100,000. While many of the one−hour photo sales will be to new customers, FFL estimates that 60% of their current overnight photo customers will switch and use the one−hour service. 16. The level of incremental sales associated with introducing the new one−hour photo service is closest to: A. $150,000. B. $120,000. C. $90,000. D. $60,000. Use the following information to answer question(s) 17 below. Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the Glucoscan 3000, to diabetic patients for $129. GSI plans on lowering their price next year to $99 per unit. The cost of goods sold for each Glucoscan unit is $50, and GSI expects to sell 100,000 units over the next year. 17. Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase sales over the next year by 30% to 130,000 units. The incremental impact of this price drop on the firm's EBIT is closest to: A. an increase of $2.4 million. B. an increase of $1.5 million. C. a decline of $2.4 million. D. a decline of $1.5 million. Use the following information to answer question(s) 18 – 21 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 each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a manufacturing cost 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 6% of its annual sales in accounts payable. The firm is in the 21% tax bracket, and has a cost of capital of 10%.

18. The incremental EBIT in the first year for the Sisyphean Corporation's project is closest to: A. $18,000. B. $8000. C. $5200. D. $11,700. 19. The incremental unlevered net income in the first year for the Sisyphean Corporation's project is closest to: A. $18,000. B. $6320. C. $8000. D. $11,700. 20. The depreciation tax shield for the Sisyphean Corporation's project in the first year is closest to: A. $8000. B. $2100. C. $2800.

D. $5200. 21. The amount of incremental income taxes that the Sisyphean Company will pay in the first year on this new project is closest to: A. $5200. B. $3500. C. $1680. D. $6300. 22. Which of the following statements is FALSE? A. Net Working Capital = Cash + Inventory + Payables − Receivables. B. Prior to 2018, companies could "carry back" losses for two years and "carry forward" losses for 20 years. C. Earnings do not represent real profits. D. Depreciation is not a cash expense paid by the firm. 23. Which of the following statements is FALSE? A. Because depreciation is not a cash flow, we do not include it in the cash flow forecast. B. Net Working Capital = Current Assets − Current Liabilities. C. Earnings are an accounting measure of firm performance. D. Tax loss carrybacks allow corporations to take losses during the current year and use them to offset income in future years. 24. Which of the following statements is FALSE? A. Firms often report different depreciation expenses for accounting and for tax purposes. B. Earnings include the cost of capital investments, but do not include non−cash charges, such as depreciation. C. Depreciation is a method used for accounting and tax purposes to allocate the original purchase cost of the asset over its life. D. Sometimes the firm explicitly forecasts free cash flow over a shorter horizon than the full horizon of the project or investment. 25. Which of the following statements is FALSE? A. The main components of net working capital are cash, inventory, receivables, and property, plant and equipment. B. ΔNWCt = NWCt − NWCt − 1. C. Most projects will require the firm to invest in net working capital. D. In the final year of a project, the firm ultimately recovers the investment in net working capital. 26. Which of the following statements is FALSE? A. The firm cannot use its earnings to buy goods, pay employees, fund new investments, or pay dividends to shareholders. B. The depreciation tax shield is the tax savings that results from the ability to deduct depreciation. C. Free Cash Flow = (Revenues − Costs − Depreciation) × (1 − τc) − Capital Expenditures − ΔNWC+ τc × Depreciation. D. Depreciation expenses have a positive impact on free cash flow. 27. Which of the following statements is FALSE? A. A firm generally identifies its marginal tax rate by determining the tax bracket that it falls into based on its overall level of pre−tax income, though C−corporations only have a single tax rate as a result of the Tax Cuts and Jobs Act of 2017. B. Free Cash Flow = (Revenues − Costs) × (1 − τc) − Capital Expenditures – ΔNWC + τc × Depreciation. C. Because only the tax consequences of depreciation are relevant for free cash flow, we should use the depreciation expense that the firm will use for tax purposes in our free cash flow forecasts. D. Net working capital is found by subtracting current assets from current liabilities. 28. Which of the following statements is FALSE? A. The incremental effect of a project on the firm's available cash is the project's free cash flow. B. To evaluate a capital budgeting decision, we must determine its consequences for the firm's available cash. C. The terminal or continuation value of the project represents the market value (as of the last forecast period) of the free cash flow from the project at all future dates. D. (1 − τc) × Depreciation is called the depreciation tax shield.

29. Which of the following cash flows are relevant incremental cash flows for a project that you are currently considering investing in? A. The cost of a marketing survey you conducted to determine demand for the proposed project B. Research and Development expenditures you have made C. The tax savings brought about by the project's depreciation expense D. Interest payments on debt used to finance the project 30. Your firm is considering building a new office complex. Your firm already owns land suitable for the new complex. The current book value of the land is $100,000. However a commercial real estate agent has informed you that an outside buyer is interested in purchasing this land and would be willing to pay $650,000 for it. When calculating the NPV of your new office complex, ignoring taxes, the appropriate incremental cash flow for the use of this land is: A. $0. B. $750,000. C. $100,000. D. $650,000. 31. You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an increase in inventory of $8000, an increase in accounts payable of $2500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is: A. $5500. B. $45,500. C. $6500. D. $10,500. 32. You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an investment of $40,000 in new equipment. This equipment will be depreciated straight line over five years. If your firm's marginal corporate tax rate is 21%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation? A. $1680 B. $14,000 C. $5200 D. $26,000 33. The Sisyphean Company is considering a new project that will have an annual depreciation expense of $2.5 million. If Sisyphean's corporate tax rate is 21%, then what is the value of the depreciation tax shield on their new project? A. $750,000 B. $1,750,000 C. $1,500,000 D. $525,000 Use the information for question(s) 34 and 35 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 each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a manufacturing cost 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 21% tax bracket, and has a cost of capital of 10%. 34. The required net working capital in the first year for the Sisyphean Corporation's project is closest to: A. $3960. B. $5400. C. $2880. D. $3600

35. The change in Net working capital from year one to year two is closest to: A. An increase of $396. B. An increase of $360. C. A decrease of $360. D. A decrease of $396. 36. Bubba Ho−Tep Company reported net income of $300 million for the most recent fiscal year. The firm had depreciation expenses of $125 million and capital expenditures of $150 million. Although they had no interest expense, the firm did have an increase in net working capital of $20 million. What is Bubba Ho−Tep's free cash flow? A. $5 million B. $150 million C. $255 million D. $170 million Use the information for question(s) 37 and 38 below. Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to set up and will generate $20 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $12 million during this year and depreciation expense will be another $3 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 21%. 37. Ignoring the original investment of $5 million, what is THSI's free cash flow for the first and only year of operation? A. $5.0 million B. $8.0 million C. $6.95 million D. $3.75 million 38. Assume that THSI's cost of capital for this project is 15%. The NPV of this temporary housing project is closest to: A. $1,043,500. B. −$435,000. C. −$650,000. D. $1,960,000. Use the information for question(s) 39 and 40 below. Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows for the first two years (in millions). Year Revenues Operating Expense Depreciation Increase in working capital Capital expenditures Marginal corporate tax rate

1 120 0 450 240 60 300 21%

2 140 0 525 280 70 350 21%

39. The incremental EBIT for the Shepard Industries project in year two is closest to: A. $510 B. $415 C. $595 D. $875 40. The incremental unlevered net income of the Shepard Industries project in year one is closest to: A. $415 B. $510

C. $600 D. $403...