Name
Date
Week 9
Score
1. Which of the following best desc ibes why the predicted incremental ea nings a ising from a
given decision are not sufficient in and of themselves to dete mine whether that decision is
wo thwhile?
A
They do not tell how the decision affects the fi m's repo ted profits from an accounting
perspective.
B
They are not easily predicted from histo ical financial statements of a fi m and its competitors.
C
These ea nings are not actual cash flows.
D
They do not show how the fi m's ea nings are expected to change as the result of a pa ticular
decision.
2. Ve non-Nelson Chemicals is planning to release a new brand of insecticide, Bee-Safe, that
will kill many insect pests but not ha m useful pollinators. Buying new equipment to
manufacture the product will cost $15 million and there will be an additional $2 million cost to
reconfigure existing plant. The equipment is expected to have a lifetime of nine years and will
be depreciated by the straight-line method over its lifetime. The fi m expects that they should
be able to sell 1,500,000 gallons per year at a p ice of $53 per gallon. It will take $36 per
gallon to manufacture and suppo t the product. If Ve non-Nelson's marginal tax rate is 40%,
what are the incremental ea nings after tax in year 3 of this project?
A
$25.5 million
B
$14.3 million
C
$23.8 million
D
$9.5 million
3. Food For Less FFL , a groce y store, is conside ing offe ing one-hour photo developing in
their store. The fi m expects that sales from the new one-hour machine will be $175,000 per
year. FFL cu rently offers ove night film processing with annual sales of $90,000. While many
of the one-hour photo sales will be to new customers, FFL estimates that 40% of their cu rent
ove night photo customers will switch and use the one-hour se vice. The level of incremental
sales associated with introducing the new one hour photo se vice is closest to ________.
A
$139,000
B
$175,000
C
$36,000
D
$70,000
4. CathFoods will release a new range of candies which contain antioxidants. New equipment to
manufacture the candy will cost $2 million, which will be depreciated by straight-line
depreciation over four years. In addition, there will be $5 million spent on promoting the new
candy line in the first year. It is expected that the range of candies will b ing in revenues of $4
million per year for four years with production and suppo t costs of $1.5 million per year. If
CathFoods' marginal tax rate is 35%, what are the incremental free cash flows in the second
year of this project?
1.
2.
3.
4.
A
$1.800 million
B
$1.400 million
C
$2.000 million
D
$0.700 million
C
B
A
A
Tips for Q2
Earning (profit) in year 3 = 1,500,000 * ($53 -36) - annual depreciation expense ($15 m / 9) = $23,833,333
Earning (profit) after tax in year 3 = $23,833,333 * (1-40%) = $14,300,000
Tips for Q4
Annual depreciation = $2m /4 = $0.5 m
Free Cash flow (in year 2) = ($4 m - $1.5 m - $0.5 m) * (1-35%) + annual depreciation ($0.5 m) = $1.8 m