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Chapter 12 Test Questions
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 straightline to a salvage value of $175,000
over the 7year life of the project. Louie’s expects to sell the equipment at the end of seven
years for $280,000. Annual sales from this project are estimated at $1.2 million with annual
operating costs estimated at $750,000. Net working capital equal to 20 percent of sales will
be required to support the project. All of the net working capital will be recouped at the end
of the project. The firm desires a minimal 14 percent rate of return on this project. The tax
rate is 34 percent. (use the standard convention discussed in class for working capital
issues)
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
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
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
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.
Answer : E
Question 3
What is the terminal cash flow from the project?
a. $184,800
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View Full Documentb. $280,000
c. $424,800
d. $484,300
e. None of the above
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
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
Answer Question 4
For this we will take information from questions 13.
CF
0
= $1,640,000, CF
16
= $356,500, CF
7
= $356,500 + $484,300 = $840,800.
The discount rate is 14% and so the NPV is $82,325.
Answer : A
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 Winter '11
 JimBrau
 Management

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