PDF 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. PDF’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 year 1 of the project?
Answer
a.
$12,800
b.
$14,400
c.
$11,400
d.
$15,200
Free cash flows represent the benefits generated from
accepting a capital-budgeting proposal.
Answer
a.
True
b.
False
Project C requires a net investment of $1,000,000 and has a
payback period of 5.6 years. You analyze Project C and decide that Year 1 free
cash flow is $100,000 too low, and Year 3 free cash flow is $100,000 too high.
After making the necessary adjustments
Answer
a.
the payback period for Project C will be longer than 5.6
years.
b.
the payback period for Project C will be shorter than 5.6
years.
c.
the IRR of Project C will increase.
d.
the NPV of Project C will decrease.
Jiffy Co. expects to pay a dividend of $2.00 per share in
one year. The current price of Jiffy common stock is $20 per share. Flotation
costs are $1.00 per share when Jiffy issues new stock. What is the cost of
internal common equity (retained earnings) if the long-term growth in dividends
is projected to be 6 percent indefinitely?
Answer
a.
10.60 percent
b.
16.00 percent
c.
16.53 percent
d.
16.60 percent
Zellars, Inc. is considering two mutually exclusive
projects, A and B. Project A costs $75,000 and is expected to generate $48,000
in year one and $45,000 in year two. Project B costs $80,000 and is expected to
generate $34,000 in year one, $37,000 in year two, $26,000 in year three, and
$25,000 in year four. Zellars, Inc.’s required rate of return for these
projects is 10%. The profitability index for Project A is;
Answer
a.
1.47.
b.
1.22.
c.
1.13.
d.
1.08.
A company has preferred stock with a current market price of
$18 per share. The preferred stock pays an annual dividend of 4% based on a par
value of $100. Flotation costs associated with the sale of preferred stock
equal $1.50 per share. The company’s marginal tax rate is 40%. Therefore, the
cost of preferred stock is;
Answer
a.
28.80%.
b.
24.24%.
c.
22.22%.
d.
14.55%.
Which of the following should be included in the initial
outlay?
Answer
a.
taxable gain on the sale of old equipment being replaced
b.
first year depreciation expense on any new equipment
purchased
c.
preexisting firm overhead reallocated to the new project
d.
increased investment in inventory and accounts receivable
If depreciation expense in year one of a project increases
for a highly profitable company,
Answer
a.
net income decreases and incremental free cash flow
decreases.
b.
net income increases and incremental free cash flow
increases.
c.
the book value of the depreciating asset increases at the
end of year one.
d.
net income decreases and incremental free cash flow
increases.
