Sample
CHAPTER 6
Making Investment Decisions with
the Net Present Value Rule
Answers to Problem Sets
1. a, b, d, g, h; c is a sunk cost. e is an overhead cost. f is not an incremental cash flow because depreciation is not a cash flow. i is a sunk cost. Est. Time: 01 - 05
2. Real cash flow = 100,000/1.04 = $96,154. The real discount rate is calculated as 1 + nominal rate / 1+ inflation rate − 1. Therefore, 1.08/1.04 − 1 = .03846.
PV = [pic]
Est. Time: 01 - 05
3. a. False. A project’s annual tax shield is equal to the depreciation amount times the tax rate.
b. False. Financing and investment decisions are kept separate.
c. False. One set of books is kept for stockholders using straight-line depreciation. Another set of books is kept for tax purposes using accelerated depreciation.
d. False. Depreciation does not affect cash flows; rather, it affects taxable income. Est. Time: 01 - 05
4. The longer the recovery period, the less the present value of depreciation tax shields. This is true regardless of the discount rate. First, calculate the PV for the depreciation schedules as shown below:
|5-Year Schedule | | | | | | | |
|Year |1 |2 |3 |4 |5 |6 | |
|Year |1 |2 |3 |4 |5 |
|Working Capital |50,000 |230,000 |305,000 |250,000 |0 |
|Cash Flows |+50,000 |+180,00 |+75,000 |−55,000 |−250,000 |
5.
Working capital = inventory + accounts receivable – accounts payable.
Cash flows = change in
Making Investment Decisions with
the Net Present Value Rule
Answers to Problem Sets
1. a, b, d, g, h; c is a sunk cost. e is an overhead cost. f is not an incremental cash flow because depreciation is not a cash flow. i is a sunk cost. Est. Time: 01 - 05
2. Real cash flow = 100,000/1.04 = $96,154. The real discount rate is calculated as 1 + nominal rate / 1+ inflation rate − 1. Therefore, 1.08/1.04 − 1 = .03846.
PV = [pic]
Est. Time: 01 - 05
3. a. False. A project’s annual tax shield is equal to the depreciation amount times the tax rate.
b. False. Financing and investment decisions are kept separate.
c. False. One set of books is kept for stockholders using straight-line depreciation. Another set of books is kept for tax purposes using accelerated depreciation.
d. False. Depreciation does not affect cash flows; rather, it affects taxable income. Est. Time: 01 - 05
4. The longer the recovery period, the less the present value of depreciation tax shields. This is true regardless of the discount rate. First, calculate the PV for the depreciation schedules as shown below:
|5-Year Schedule | | | | | | | |
|Year |1 |2 |3 |4 |5 |6 | |
|Year |1 |2 |3 |4 |5 |
|Working Capital |50,000 |230,000 |305,000 |250,000 |0 |
|Cash Flows |+50,000 |+180,00 |+75,000 |−55,000 |−250,000 |
5.
Working capital = inventory + accounts receivable – accounts payable.
Cash flows = change in