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Chapter 12: Capital Budgeting and Estimating Cash Flows

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1. All of the following influence capital budgeting cash flows EXCEPT:

accelerated depreciation.

salvage value.

tax rate changes.

method of project financing used.

2. In proper capital budgeting analysis we evaluate incremental

accounting income.

cash flow.

earnings.

operating profit.

3. The estimated benefits from a project are expressed as cash flows instead of income flows because:

it is simpler to calculate cash flows than income flows.

it is cash, not accounting income, that is central to the firm's capital budgeting decision.

this is required by the Internal Revenue Service.

this is required by the Securities and Exchange Commission.

4. In estimating "after-tax incremental operating cash flows" for a project, you should include all of the following EXCEPT:

sunk costs.

opportunity costs.

changes in working capital resulting from the project, net of spontaneous changes in
current liabilities.

effects of inflation.

5. A capital investment is one that

has the prospect of long-term benefits.

has the prospect of short-term benefits.

is only undertaken by large corporations.

applies only to investment in fixed assets.

6. Taxing authorities allow the fully installed cost of an asset to be written off for tax purposes. This amount is called the asset's

cost of capital.

initial cash outlay.

depreciable basis.

sunk cost.

7. Adam Smith is considering automating his pin factory with the purchase of a $475,000 machine. Shipping and installation would cost $5,000. Smith has calculated that automation would result in savings of $45,000 a year due to reduced scrap and $65,000 a year due to reduced labor costs. The machine has a useful life of 4 years and falls in the 3-year property class for MACRS depreciation purposes. The estimated final salvage value of the machine is $120,000. The firm's marginal tax rate is 34 percent. The incremental cash outflow at time period 0 is closest to

$280,000.

$380,000.

$480,000.

$580,000.

8. (See information in Question #7 above.) The "cost" of this asset that, by law, may be written off over time "for tax purposes" is closest to

$280,000.

$380,000.

$480,000.

$580,000.

9. In general, if a depreciable asset used in business is sold for more than its depreciated (tax) book value, any amount realized in excess of book value but less than the asset's depreciable basis is considered a

"capital gain" and is taxed at the corporate capital gains tax.

"recapture of depreciation" and is taxed at the corporate capital gains rate.

"capital gain" and is taxed at a rate equal to the firm's ordinary tax rate, or a maximum of
35 percent.

"recapture of depreciation" and is taxed at the firm's ordinary income tax rate.

10. Under the Modified Accelerated Cost Recovery System (MACRS), an asset in the "5-year property class" would typically be depreciated over years.

four

five

six

seven

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