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Capital budgeting

Questions 72-76 address a capital budgeting problem and are related, though there are assumptions made in sequential questions to avoid an initial error causing all subsequent responses to be in error.

Consider the following for questions 72-76: A new product is being considered by Stanton Corp. An outlay of $40,000 is required for equipment and an additional net working capital investment of $1000 is required. The project is expected to have a 4 year life and the equipment will be depreciated on a straight line basis (equal annual amount) to a $4,000 book value.

Producing the new product will reduce current manufacturing expenses by $5,000 annually and increase earnings (revenue) before depreciation and taxes by $6,000 annually. Stanton's marginal tax rate is 40 percent. Stanton expects the equipment will have a market salvage value of $10,000 at the end of 4 years.

72 What is the total cost at time zero of accepting this project?
a. 40,000
b. 41,000
c. 30,000
d. 31,000
e. Insufficient information to answer

73 What is the depreciation each year over the machine's 4 year life?
a. 9,000
b. 9,250
c. 10,000
d. 10,250
e. Insufficient information to answer.

74 Regardless of your answer to number 73 above, ASSUME DEPRECIATION = $8,000 per year. What is the project's after-tax operating cash flow during years 1-4 from the machine?
A. 11,000
b. 3,000
c. 6,600
d. 14,600
e. 9,800

75 Assuming the equipment is sold for the expected $10,000 market salvage value at the end of its 4 year life, compute the after tax salvage value of the equipment. Note: this question addresses ONLY the after-tax salvage value, i.e., the after-tax cash flow from the sale of the equipment. This question does NOT address any other terminal year cash flows.
a. 4,000
b. 6,000
c. 7,600
d. 10,000
e. none of the above

76 Regardless of your answer to number 74 & 75 above, ASSUME the project's after-tax operating cash flow during years 1-4 from the machine = $8,000 and the after tax salvage value = $7,000. What is the TOTAL cash flow expected from this project in the terminal year, including any initial investment amounts assumed to be recovered? Include all terminal year flows as well as the terminal year operating cash flow of 8,000 assumed.
a. 7,000
b. 8,000
c. 15,000
d. 16,000
e. none of the above

Solution Preview

72. Total cost at time zero = Cost of equipment + additional net working capital = 40,000+1,000=$41,000

73. The cost is $40,000 and there is a salvahe value of $4,000 and the life of the equipment is 4 years
Depreciation per year = ...

Solution Summary

The solution explains some questions relating to capital budgeting

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