finance Ch-9

# finance Ch-9 - Chapter 9Cash Flow and Capital Budgeting...

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Chapter 9—Cash Flow and Capital Budgeting MULTIPLE CHOICE 1. Gamma Electronics is considering the purchase of testing equipment that will cost \$500,000. The equipment has a 5-year lifetime with no salvage value. Assume the new machine will generate after- tax savings of \$100,000 per year for the five years. If the firm has a 15% cost of capital, what is the equivalent annual cost of the equipment? a. \$32,924 b. \$42,746 c. \$49,158 d. \$37,863 ANS: C NPV = -500,000 + 100,000/1.15 + 100,000/1.15 2 + 100,000/1.15 3 + 100,000/1.15 4 + 100,000/1.15 5 = - 164,784 Suppose the equivalent annual cost is x, then x/1.15 + x/1.15 2 + x/1.15 3 + x/1.15 4 + x/1.15 5 = -164,784 x = -49,158 DIF: M REF: 9.4 Special Problems in Capital Budgeting 2. Thompson Manufacturing must choose between two types of furnaces to install. Model A has a 6 year life, and an NPV of \$5,000. Model B has a 5 year life, and an NPV of \$4,200. The relevant discount rate is 12%. Which model should be chosen? What’s the annual cash flow from that model? a. Model B; \$1,165 b. Model B; \$840 c. Model A; \$833 d. Model A; \$1,216 ANS: D Suppose the annual annuity of model A is x, and that of model B is y. x/1.12 + x/1.12 2 + x/1.12 3 + x/1.12 4 + x/1.12 5 + x/1.12 6 = 5000 x = \$1216 y/1.12 + y/1.12 2 + y/1.12 3 + y/1.12 4 + y/1.12 5 = 4200 y = \$1165 DIF: M REF: 9.4 Special Problems in Capital Budgeting 3. A firm is evaluating two machines. Both machines meet the firm’s quality standard. Machine A costs \$40,000 initially and \$1,000 per year to maintain. Machine B costs \$24,000 initially and \$2,000 per year to maintain. Machine A has a 6 year useful life and machine B has a 3 year useful life. Both ma- chines have zero salvage value. Assume the firm will continue to replace worn-out machines with sim- ilar machines, and the discount rate is 7%. Which machine should the firm purchase? a. Machine A b. Machine B c. The firm is indifferent to the two machines d. Can’t tell from the given information

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ANS: A Cash outflows for two machines: Year Machine A Machine B 0 40,000 24,000 1 1,000 2,000 2 1,000 2,000 3 1,000 2,000 4 1,000 26,000 5 1,000 2,000 6 1,000 2,000 NPV: \$44,767 \$51,843 DIF: H REF: 9.4 Special Problems in Capital Budgeting 4. Capital budgeting must be placed on an incremental basis. This means that ______ must be ignored and _______ must be considered. a. sunk cost; opportunity cost b. sunk cost; financing cost c. cannibalization; opportunity cost d. opportunity cost; net working capital ANS: A DIF: E REF: 9.2 The Relevant Cash Flows 5. Roger is considering the expansion of his business into a property he purchased two years ago. Which of the following items should not be included in the analysis of this expansion? a.
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## This note was uploaded on 09/29/2011 for the course FINANCE 3383 taught by Professor Jin during the Spring '11 term at Texas Pan American.

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finance Ch-9 - Chapter 9Cash Flow and Capital Budgeting...

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