Unit 7 Review Questions (2024) - Solutions
1. ARX Company Limited is considering a new project. The company paid last month $200,000
to a consulting firm to do an assessment of the project. The project requires an immediate cash
outlay of $1.5 million for equipment and $750,000 for materials. It already owns the land
which cost $8 million six years ago and has an $8.5 million current market value. The proper
cash flow amount to use for year zero in evaluating this project for capital budgeting purposes
is:
A) $10,750,000 outflow
B) $13,100,000 inflow
C) $20,850,000 outflow
D) $10,950,000 inflow
E) $22,750,000 outflow
Cash flow = $1,500,000 + 750,000 + 8,500,000
Cash outflow = $10,750,000
Answer: A
2.The Hochiu Taylor Inc. has cash revenue of $100,000, cash expenses of $60,000, depreciation
expense of $20,000. If the company’s tax rate is 30%, what is the firm’s cash flow from
operation?
A) $28,000
B) $34,000
C) $33,000
D) $36,000
E) $8,000
Cash flow from operation
= (Revenue – cash expenses) (1-tax rate) + (Depreciation expense)(tax rate)
= (100,000-60,000) (1-0.3) + (20,000) (0.30)
= $34,000
Answer: B
3.The S.A.T. Company has recently bought a new hardware, which belongs to Class 10 (with
CCA rate of 30%). The cost of the hardware is $150,000, the expected economic life of the
hardware is 10 years, at the end of which it has a salvage value of $10,000.
[Assume that the Half Year Rule applies]. The company’s tax rate is 35% and the cost of capital
is 10%. The present value of the CCA tax shield of this new hardware is:
A) $33,730
B) $35,898
C) $36,573
D) $37,585
E) $38,363
CdTc 1 0.5r SdTc 1
PV of CCA tax shield = r d 1 r d r 1 r =
t
150,000 0.3 0.35 1 0.5 0.10 (10,000)(. 3)(. 35)
10
0.10 0.3 1 0.10 (.3 .10)(1 0.10)
= 39,375 x 0.954545 - 2625.00 x 0.385543
= 37,585.23 - 1012.05
= $36,573.18
Answer: C
4. The Heath Manufacturing Inc. is a new company that has started operation recently. In the
first year of operation, the balance sheet has the following changes: short term marketable
securities have increased by $123,000; account receivable has increased by $88,000; inventory
has increased by $65,000; fixed assets have increased by $250,000; current liabilities have
increase by $50,000. What is the change in cashflow that is due to the change in net working
capital in the first year?
A) cash outflow of $226,000
B) cash inflow of $226,000
C) cash outflow of 510,000
D) cash inflow of $50,000
E) change in net working capital does not change cash flow
Increase in Net Working Capital = 123,000 + 88,000 + 65,000 - 50,000 = 226,000. This means
that there is a cash outflow of $226,000.Answer: A
5. What is the amount of the operating cash flow for a firm with $500,000 profit before tax,
$100,000 depreciation expense, and a 35 percent marginal tax rate?
A) $260,000
B) $325,000
C) $360,000
D) $425,000
E) $390,000
Go to Formula Sheet (Cash Flow from Operations - Method 2)
CFop = Net Income + Depreciation
Net income = after-tax income = 500,000 x (1-.35) = 325,000
CFop = 325,000 + 100,000 = 425,000Answer: D
6. The KHO Inc. has recently paid $300,000 for a fleet of trucks, which belong to a class with
CCA rate of 30%. The company’s tax rate is 35%. What is the CCA tax shield in year 2? Assume
that the half-year rule applies.
A) 22,050
B) 35,075
C) 45,000
D) 18,750
E) 26,775
Year UCC CCA Tax Shield (= CCA x tax rate)
1 300,000 45,000 15,750
2 255,000 76,500 26,775
Answer: E
7. The HHH Company has just acquired a trademark for $200,000. The trademark belongs to a
CCA class which can be depreciated on a straight-line basis for CCA tax purposes. The company
will depreciate the trademark over 10 years with a salvage value of $20,000. The half year rule
does not apply to this class of assets.The tax rate is 35% and the discount rate is 12%. Calculate
the present value of the CCA tax shield.
A) 23,000
B) 39,552
C) 35,596
D) 11,118
E) 25,500
The annual CCA expense = (200,000-20,000)/ (10) = 18,000
Tax shield due to CCA = (.35) (18,000) = 6,300 per year
Calculator inputs: PMT=6,300; N=10; I/Y=12%; FV=0.
COMPUTE PV = 35,396.41
ANSWER: C
8. What is the impact of the change in Net Working Capital on the NPV of a 5-year project if the
discount rate is 12%? The Net Working Capital over the life of the project is as follows:
Time Net Working Capital
0 $100,000
1 $120,000
2 $130,000
3 $140,000
4 $140,000
5 0
A) $22,375
B) $19,087
C) $46,493
D) $54,213
E) $57,890
Net Working Capital Changes (cash outflow + sign; cash inflow -)
Year 1 $120,000-100,000=20,000 outflow
Year 2 $130,000-120,000=10,000 outflow
Year 3 $140,000-130,000=10,000 outflow
Year 4 $140,000-140,000=0
Year 5 $0-140,000= -140,000 inflow
The impact of the changes in NWC on NPV = (-20,000)/(1.12) + (-10,000)/(1.12)^2 +
(-10,000)/(1.12)^3 + (140,000)/(1.12)^5 = 46,492.88
Answer: C
9. As part of a project, the YYZ Company acquired a machine that belongs to the class with CCA
rate of 30%. The cost of the machine is $400,000; the expected economic life is 10 years; the
cost of capital is 10%; the company’s tax rate is 35%; and the half year rule applies. What is the
impact of a salvage value of $30,000 on the NPV of the project?
A) $30,000
B) $23,345
C) $11,566
D) $8,530
E) $3,036
There are two impacts on NPV:
1. Positive cashflow--PV of salvage value in year 10 = (30,000)/(1.1)^(10) = 11,566.30
2. Negative impact on the PV of CCA tax shield
= (-30,000)(.35)(.30)/[(.10+.30)(1.1)^(10)]
= -3,036.15
Total impact on NPV = 11,566.3-3,036.15 = 8,530.15
ANSWER: D
10. (Comprehensive) Wagyu Industries plans to buy a piece of equipment that will help the
company to save $125,000 per year (pre-tax) for 10 years. The equipment will require an initial
investment of $1million today and will cost $35,000 per year for 10 years to operate. The
equipment is in the 25% CCA class (half year rule applies) and can be sold for $100,000 at the
end of 10 years. Wagyu has a corporate tax rate of 35% and the required return on similar
projects is 10%, should Wagyu buy the product?
A) Yes, because the NPV is $129,666
B) Yes, because the NPV is $156,767
C) Yes, because the NPV is $165,566
D) No, because the NPV is -$167,677
E) No, because the NPV is -$ 372,990
CFop:1 to 10 = (125,000 – 35,000) x (1-.35) = 58,500/year (excl CCATS)
NPV = -C0 + PV[NWC] + PV[CFop, excl TS] + PV CCA tax shield (PVCCATS) + PV[S]
1. C0 = - $1,000,000
2. NWC = 0 (not mentioned)
3. PV[CFop]: PMT = 58,500; N=10: I/Y=10; FV=0 ; COMP PV = $359,457.18
4. PVCCATS:
=
0.10+ 0.25 [
1,000,000× 0.25 ×0.35 1+(0.5 × 0.10)
1+0.10
−¿]
= [ ][
87,500 1.05
0.35 1.10
−
8,750
0.35
×0.3855
]
= 238,636.36 – 9,637.50 = $ 228,998.86
5. PV[S] = 100,000/(1.10)^10 = $38,554.33
NPV = – 1,000,000 + 359,457.18 + 228,998.86 +38,554.33
= -372,989.63
Answer: E
11. (Comprehensive) Meme Corporation plans to purchase a new equipment at a cost of
$800,000 (CCA rate 30%) that has a useful life of 6 years with no salvage value. [Half-Year Rule
applies]. This equipment needs a further investment in working capital of $40,000 today; the
working capital will be recovered at the end of year 6. The firm’s tax rate is 33%. The new
equipment will result in pre-tax savings of $450,000 per year over each of the 6 years. The
company expects a minimum return on investment of 11%. Based in this information, should
the company buy the equipment?
A) Yes, because the NPV is $188,443
B) No, because the NPV is negative $333,021
C) No, because the NPV is negative $397,463
D) No, because the NPV is negative $409,983
E) Yes, because the NPV is $640,492
CFop:1 to 6 = ($450,000) x (1-.33) = $301,500/year (excl CCATS)
NPV = -C0 + PV[NWC] + PV [CFop, excl CCATS] + PV of CCA tax shield (PVCCATS) + PV[S]
1. C0 = - $800,000
2. PV[NWC] = -$40,000 + ($40,000)/(1.11)^6 = -$18,614
3. PV[CFop]: PMT = 301,500; N=6: I/Y=11; FV=0; COMP PV = $1,275,507
4. PVCCATS:
PV of CCATS = (800,000)(.30) (.33) x (1 + .5(.11))
(.30 + .11) (1 + .11)
= $183,599
5. PV[S] = 0
NPV = -800,000 – 18,614 + 1,275,507 + 183,599 + 0
= $640,492 Answer: E
12. The Ronald Company plans to acquire a machine that is in the class with CCA rate of 20%.
The cost of the machine is $500,000. The company’s tax rate is 35%, the cost of capital is 10%.
The half-year rule applies. What is the CCA in year 3?
A) $67,000
B) $72,000
C) $58,000
D) $49,000
E) $64,000
Year UCC CCA
1 $500,000 $50,000
2 $450,000 $90,000
3 $360,000 $72,000
ANSWER: B
13.Calculate the annual cash flow from operations for a project with sales of 5 million units at a
price of $2 per unit, variable cost of $0.75, annual fixed cost (excluding depreciation) of $3
million and annual depreciation of $2 million. Assume the corporate tax rate is 30%.
A) $ 375,000
B) $ 875,000
C) $ 1,250,000
D) $2,875,000
E) $3,875,000
CFop = NI + Depreciation
Sales Revenue (Price * Units) $10,000,000
Variable Cost (VC * Units) -$3,750,000
Fixed Cost -$3,000,000
Depreciation -$2,000,000
Operating Income before taxes $1,250,000
Tax 30% $375,000
Net income $875,000
Add back Depreciation $2,000,000
Cash flow from operations $2,875,000
ANSWER: D
14. Which of the following would result in negative cash flow of a project?
A) Tax shield due to CCA.
B) Salvage value.
C) Increase in net working capital.
D) Recovery of account receivables.
E) Increase in account payables.
ANSWER: C
15. Which of the following should not be included when using discounted cash flow analysis to
evaluate a project?
A) The historical cost of land on which the project will be built.
B) Annual tax savings.
C) Changes in levels of net working capital.
D) Reduced sales of an existing product.
E) Increase sales of an existing product.
ANSWER: A
Historical cost should not be included in NPV project analysis.
16. A company owns a building that is totally paid for. This building has been sitting idle for the
past three years. Now the company is trying to analyze a project that would include the use of
this building. Which of the following costs should be included in the analysis?
I. The property taxes paid on the building over the past three years.
II. The insurance paid on the building over the past three years.
III. The current market value of the building.
IV. The cost to survey the lot to construct a drainage pond required for the site
A) I and II only
B) III and IV only
C) I, II, and III only
D) I, II, and IV only
E) II, III, and IV only
ANSWER: B
