Question Details

Marshall-Miller & Company is considering the purchase of a new machine 



1.	A firm is considering a new project whose risk is greater than the risk of the firm- average project, based on all methods for assessing risk.  In evaluating this project, it would be reasonable for management to do which of the following?

a.	Increase the estimated IRR of the project to reflect its greater risk.
b.	Increase the estimated NPV of the project to reflect its greater risk.
c.	Reject the project, since its acceptance would increase the firm- risk.
d.	Ignore the risk differential if the project would amount to only a small fraction of the firm- total assets.
e.	Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
	
2.	Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset.  Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%.  The company is considering the following projects:

	Project	Risk	Expected Return
	A	High	15%
	B	Average	12%
	C	High	11%
	D	Low	9%
	E	Low	6%

Which set of projects would maximize shareholder wealth?

a.	A and B.
b.	A, B, and C.
c.	A, B, and D.
d.	A, B, C, and D.
e.	A, B, C, D, and E.
	
3.	As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data.  What is the Year 1 cash flow?

Sales revenues, each year	$42,500
Depreciation	$10,000
Other operating costs 	$17,000
Interest expense	$4,000
Tax rate	35.0%

a.	$16,351
b.	$17,212
c.	$18,118
d.	$19,071
e.	$20,075
	
4.	Marshall-Miller & Company is considering the purchase of a new machine for $50,000, installed.  The machine has a tax life of 5 years, and it can be depreciated according to the following rates.  The firm expects to operate the machine for 4 years and then to sell it for $12,500.  If the marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end of Year 4? 

	Year	Depreciation Rate
	1	0.20
	2	0.32
	3	0.19
	4	0.12
	5	0.11
	6	0.06

a.	$8,878
b.	$9,345
c.	$9,837
d.	$10,355
e.	$10,900
	
5.	TexMex Food Company is considering a new salsa whose data are shown below.  The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required.  Revenues and other operating costs are expected to be constant over the project's 3-year life.  However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows.  What is the project's NPV?  (Hint:  Cash flows are constant in Years 1-3.) 

WACC	10.0%
Pre-tax cash flow reduction for other products (cannibalization)	-$5,000
Investment cost (depreciable basis)	$80,000
Straight-line deprec. rate	33.333%
Sales revenues, each year for 3 years	$67,500
Annual operating costs (excl. deprec.)	-$25,000
Tax rate	35.0%

a.	$3,636
b.	$3,828
c.	$4,019
d.	$4,220
e.	$4,431




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