Which of the tolhowing rales is CORRECT for capital bdgsting nays Tr a pshct is

Question

Which of the tolhowing rales is CORRECT for capital bdgsting nays Tr a pshct is competitive with some of the fim's other peoducts, this fuct should be ncorporated into the estienate of the relevant cash lows However, if the new product is complemenkary to some of the fiem's other products, this fact need not be reflected in the h. Sunk costs are not inchaded in the annual cash flows, bout they must be deducted from the PV or the project's her cost, when reaching the socopireject decision. Only incremental cash flows, which are the cash flows that would resuls if a project is aceepted, are relevant when making acceptiveject decisions for capital budgeting d. The interest paid on fands borrowed to finance a project must be included in estimates of e. A proposed project's estimated net income as determined by the firm's accountants, the project's cash flows using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the projeet's cost, the project should be aceepted. I4. Clemson Software is considering a new project whose data are shown below. The required equipment bas a 3-year tax life, after which it will be worthless, and it will be depreciated by the straight-line method over 3 years. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's Year I cash flow? Equipment cost (depreciable basis) I e $82,000 33.333% $60,000 $25,000 35.0% Straight-line depreciation rate Sales revenues, each year Operating costs (exel. depr.) Tax rate a. $35,872 b. $32,640 C. $39,426 d. $39,103 e. $32,317 15. Suppose Tapley Inc. uses a wACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects? a. Without information about the projects' NPVs we cannot determine which one or ones should be accepted. Project C, which has above-average risk and an IRR-11%. Project B, which has below-average risk and an IRR-8.5%. Project A, which has average risk and an IRR = 9%. All of these projects should be accepted as they will produce a positive NPV. b. c. d. e.

Explanation / Answer

Since, there are multiple questions in the post, the first four have been answered.

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Question 13)

Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. (which is Option C)

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Explanation:

Capital budgeting analysis involves evaluation of different projects on the basis of cash flows produced by them. The various techniques of capital budgeting analysis (like NPV, IRR and Cash Payback Method) use cash flows as the basis for making investment decisions. Each project is evaluated independently and therefore, only incremental cash flows are considered for capital budgeting analysis.

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Question 14)

The cash flow for year 1 is calculated with the use of following equation:

Cash Flow Year 1 = (Sales Revenue - Operating Cost - Depreciation)*(1-Tax Rate) + Depreciation

Using the values provided in the question, we get,

Cash Flow Year 1 = (60,000 - 25,000 - 33.333%*82,000)*(1-35%) + 33.333%*82,000 = $32,317 (which is Option E)

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Question 15)

Project B, which has below-average risk and an IRR = 8.5%. (which is Option C)

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Explanation:

The WACC used by Tapley for evaluating below-average risk projects is 8%. Therefore, any project which has below-average risk and an IRR greater than or equal to the WACC of 8% will be accepted. In the given case, Project B has below-average risk and an IRR of 8.5% which is more than the WACC of 8%. In simple words, the cost of capital is less than the expected internal rate of return from the project. Therefore, Project B will be accepted.

Project A's IRR of 9% is less than the WACC of 10% and therefore, will not be accepted.

Project C's IRR of 11% is less than the WACC of 12% and therefore, will not be accepted.

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Question 16)

There is an “opportunity cost” associated with using retained earnings, hence they are not “free.” (which is Option B)

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Explanation:

The WACC has four main components - debt, preferred stock, common stock and retained earnings. The retained earnings if not distributed to shareholders will indicate an opportunity cost in the form of return, the shareholders would have earned if the earnings wouldn't have been reinvested by the company. Therefore, the value of retained earnings cannot be considered as "Cost" free and the company will have to estimate the cost of retained earnings while determining the WACC.

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