Question

1. Which one of the following is an example of mutual exclusive projects?

I. A piece of land may be either used for the extension of the existing plant or the building of a more efficient headquarters for the company

II. Expanding the plant or relocating the company’s head office to a new location

a) I only

b) II only

c) Both I and II

d) Neither I nor II

2. Investment in net working capital is included in the cash flows:

a) to reflect the cash flows from buying and selling on credit

b) to reflect the financing decisions

c) to reflect opportunity costs

d) all of the above

3. Given the following information on a project: initial capital cost = $500,000; installation costs associated with the capital asset = $25,000; R&D costs associated with the project = $50,000; associated opportunity costs = $80,000; increase in raw materials inventory = $10,000, which of these amounts is included with working capital?

a) $500,000

b) $80,000

c) $10,000

d) $25,000

4. Ontario Courier Service is considering investing in a capital asset that costs $64,000. The project also requires an investment in net working capital of $8,000. The project will generate annual after-tax operating income of $20,800 for the next four years. The asset has a CCA rate of 20 percent and is expected to sell for $7,200 at the end of four years. The firm’s cost of capital is 15 percent and marginal tax rate is 35 percent. Assume the asset class remains open after the asset is sold. What is the ending after-tax cash flow?

a) $7,398

b) $15,200

c) $21,855

d) $23,002

5. A firm taking a conservative approach with respect to its cash balance is most likely to be:

a) holding as much credit as possible.

b) holding as much cash as possible.

c) holding as much borrowing ability as possible.

d) holding as much long-term debt as possible.

Answer 1

Q 1.

Ans: Here Option C is Correct. Both statements are Mutually Exclusive Projects.

According to principle stated in Mutually exclusive projects no two objects can occure simultaneously. In this question, both statments have mutually exclusive projects.i.e use of land either building or expanding for other purpose cannot happen at one time so it is mutually exclusive event as like statement second.

Q 2.

Ans: Investment in net working capital is included in cash flows to reflect the financing decision of firm because investment makes changes in the net working capital, which comes under financing decision of firm to make cash flow statement.

Q 3.

Ans: According to given question, here capital costs given= $ 500,000 , insttallation cost = $ 25000 , R&D cost= $50,000 , opportunity cost = $ 80,000 & increase in raw material= $10,000

Except Increase in raw material, all other cost associated with the asset are capital expense which are outside of working capital. Increase in raw material is a change in current asset.

Net working capital = difference in current asset and current liabilities. Hence it is justified.

Q 4.

Ans; Given Capital assetr cost= $ 64,000,Investment in net working capital = $ 8000,Firm's annual after tax operating income=$20,800 for next four years, sell=$7200, cost of capital =15%, margiunal tax rate = 35%.

Ending after tax cash flows is as follows:

ECF= Investment in net working capital + sell value after four years= $8000+ $7200= $15200

which is option b is correct.

Q 5.

Ans: A firm is taking a conservative working capital policy with respect to its cash balance it means the firm has much more cash with it. In this approach the firm buffer against risk as it has more cash balance at its bank.

Hence option b is correct i.e it has much cash as possible.