Chapter 12 Test Questions

Chapter 12 Test Questions - Chapter 12 Test Questions Use...

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Chapter 12 Test Questions
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Use this information to answer questions 1 through 5. Louie’s Leisure Products is considering a project which will require the purchase of $1.3 million in new equipment. Shipping and installation will be an additional $100,000. For tax purposes, the equipment will be depreciated straight-line to a salvage value of $175,000 over the 7-year life of the project. Louie’s expects to sell the equipment at the end of seven years for
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Question 1 Initial outlay for the project a. $1,060,000 b. $1,400,000 c. $1,540,000 d. $1,640,000 e. None of the above
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Answer Question 1 The initial outlay is the cost of the equipment + the installation costs + net working capital investments. So it is $1,300,000 + $100,000 + (20% * $1,200,000) = $1,640,000. Answer : D
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Question 2 What is the amount of the free cash flow in year one? a. $47,600 b. $72,000 c. $95,200 d. $144,000 e. None of the above
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Answer Question 2 To get this we take the annual sales $1,200,000 minus the annual costs $750,000 minus depreciation (to find depreciation we take the cost plus installation $1,400,000 minus salvage value $175,000 and divide by 7 years: $1,225,000/7 = $175,000.) Now we have EBIT of $275,000. After taxes (34%) this would be $181,500. Now we add back in depreciation $175,000 as it is not a cash flow to get $356,500.
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Question 3 What is the terminal cash flow from the project? a. $184,800 b. $280,000 c. $424,800 d. $484,300 e. None of the above
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Answer Question 3 First Louie’s expects to sell the equipment for $280,000. This is greater than the salvage value $175,000 and so taxes must be paid on the difference $280,000 - $175,000 = $105,000. $105,000 * 34% = $35,700. So we get $280,000 - $35,700 (taxes) + $240,000 (working capital found in Question 1) = $484,300. Answer : D
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Question 4 What is the NPV of the project? (round to nearest $1000) a. $82,000 b. $243,000 c. $841,000 d. $3,362,000 e. None of the above
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For this we will take information from questions 1-3. CF0 = -$1,640,000, CF1-6 = $356,500, CF7 = $356,500 + $484,300 = $840,800. The discount rate is 14% and so the NPV is $82,325. Answer : A
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Chapter 12 Test Questions - Chapter 12 Test Questions Use...

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