Chapter 12 Sample Test Questions

# Chapter 12 Sample Test Questions - Chapter 12 Test...

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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 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 \$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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b. \$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 1-3. CF 0 = -\$1,640,000, CF 1-6 = \$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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Chapter 12 Sample Test Questions - Chapter 12 Test...

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