FM- Ch. 5

Gunning Industries is considering investment in a new machine which has a five year life. The investment in the new machine would also require an immediate increase in working capital of $35,000, which would be fully recovered at the end of five years. Gunning is subject to a 40% corporate tax rate and has a cost of capital of 10%.

What is the effect of working capital on the net present value of the investment?

• 1. $7,959

• 1. $10,680

• 1. $13,265

• 1. $35,000

Moore Co is considering acquiring a new machine for $105,000. The machine is estimated to have a 10-year life and scrap value of $5,000. Over its life the machine is expected to produce 2,000 units each year with a sales price per unit of $500 and combined material and labour costs of $450 per unit. Tax-allowable depreciation is available on a straight-line basis on cost over five years. Moore has a 40% tax rate and tax is paid in the year of returns.

What is the after-tax cash flow for the tenth year of the project?

• 1. $81,000

• 1. $68,400

• 1. $63,000

• 1. $60,000

What is a balancing allowance?

• 1. A government grant

• 1. A tax loss on disposal

• 1. An asset’s scrap value

• 1. Impairment to an asset’s value

Carter Co paid $1m for land three years ago. Carter estimates that it could sell the land today for $1.2m. If the land is not sold, Carter plans to develop the land at an initial cost of $1.5m. Carter estimates the net operating cash inflow during the first year following development would be $500,000.

What is Carter’s opportunity cost of the development?

• 1. $1.5m

• 1. $1.2m

• 1. $1.0m

• 1. $0.5m

Paisley Co plans to purchase a machine costing $13,500. The machine will save labour costs of $7,000 in the first year. Labour rates in the second year will increase by 10%. The general rate of inflation is 8% and the company’s real cost of capital is estimated at 12%.

The machine has a two-year life with an estimated scrap value of $5,000.

What is the NPV (to the nearest $10) of the proposed investment?

• 1. $550

• 1. $770

• 1. $970

• 1. $1,150

Gunning is considering investment in a new machine. The following information is provided:

• (i) The new machine will cost $190,000 and has a five-year life with zero scrap value.

• (ii) The investment will also require an increase in working capital of $35,000.

• (iii) Tax-allowable depreciation is available on a straight-line basis.

• (iv) Gunning is subject to a 40% tax rate and has a 10% cost of capital. Tax is paid at the end of the year in which profits are earned.

What is the present value of the tax saving on the first year’s tax-allowable depreciation?

• $13,817

• $13,800

• $13,815

• $13,500

Wendy’s Shop acquires an asset for $100,000 that has no residual value and a 10-year life. Wendy’s tax rate is 40%. Tax-allowable depreciation is available on a straight-line basis.

What is Wendy’s annual tax saving from the asset?

• 1. $10,000

• 1. $6,000

• 1. $4,000

• 1. $2,000

ABC Co plans to buy a new machine. The cost of the machine is $100,000 and it has a five-year life with no disposal value. The machine will be depreciated on a straight-line basis which matches the policy for tax-allowable depreciation. The machine will increase annual operating cash flows by $50,000. ABC’s profit tax rate is 35%.

What is the annual after-tax cash flow generated by the machine?

• 1. $19,500

• 1. $30,000

• 1. $32,500

• 1. $39,500

A company has a nominal cost of capital of 21% per year. The general inflation rate is 9% per year.

What is the company’s real cost of capital?

• 1. 9%

• 1. 11%

• 1. 12%

• 1. 21%

A company is considering investment in new labour-saving equipment costing $1m. The current wage rate is $5 per hour but this is expected to increase by 5% each year into the foreseeable future. The equipment is expected to save 20,000 labour hours per year.

The company’s nominal cost of capital is 15.5%.

What is the present value of the savings in wage costs over a 10-year planning period (to the nearest $000)?

• 1. $385,000

• 1. $558,000

• 1. $615,000

• 1. $676,000