All of the following items are included in discounted cash flow analysis except
Answer(s): C
Discounted cash flow analysis, using either the internal rate of return (IRR) or the net present value (NPV) method, is based on the time value of cash inflows and outflows. All future operating cash savings are considered, as well as the tax effects on cash flows of future depreciation charges. The cash proceeds of future asset disposals are likewise a necessary consideration. Depreciation expense is a consideration only to the extent that it affects the cash flows for taxes. Otherwise, depreciation is excluded from the analysis because it is a noncash expense.
The use of an accelerated method instead of the straight-line method of depreciation in computing the net present value of a project has the effect of
Accelerated depreciation results in greater depreciation in the early years of an asset's life compared with the straight-line method. Thus, accelerated depreciation results in lower income tax expense in the early years of a project and higher income tax expense in the later years. By effectively deferring taxes, the accelerated method increases the present value of the depreciation tax shield.
The NPV of a project has been calculated to be $215000. Which one of the following changes in assumptions would decrease the NPV?
Answer(s): D
An increase in the discount rate would lower the net present value, as would a decrease in cash flows or an increase in the initial investment.
A disadvantage of the net present value method of capital expenditure evaluation is that it
The NPV is broadly defined as the excess of the present value of the estimated net cash inflows over the net cost of the investment. A discount rate has to be stipulated by the person conducting the analysis. A disadvantage is that it does not provide the true rate of return for an investment, only that the rate of return is higher than a stipulated discount rate (which may be the cost of capital).
In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1. The following information is being considered by Gunning Industries:· The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000.· The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.· The investment in the new machine will require an immediate increase in working capital of $35,000. This cash outflow will be recovered after 5 years. · Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years and zero salvage value.· Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to analyze investments and will employ the following factors and rates:Gunning Industries' net cash outflow in a capital budgeting decision is
The machine costs $160,000 and will require $30,000 to install and test. In addition, the company will have to invest in $35,000 of working capital to support the production of the new machine. Thus, the total investment necessary is $225,000.
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