Week 8

Q.1.
Product cannibalisation involves:
A. Erosion of sales of an existing product due to own new product

B. Erosion of sales of an existing product due to an own older product
C. Erosion of sales due to a competitor’s existing product
D. Erosion of sales due to a competitor’s new product
Q.2. The incremental cash flows related to a capital investment project are easiest to identify when:
A. sunk costs exist.

B. opportunity costs are significant.
C. a proposed project has no effect on the current operations.
D. erosion of cash flow is expected to occur.
Q.3. Your scientists just discovered that the engine-oil additive they developed three years ago
makes a great men's aftershave when diluted properly using certain chemicals. You are analysing the
proposal to commence production of this after shave. For this analysis, the Rs. 125,000 that was
spent doing research to develop the engine-oil additive should be treated as:
A. a cash outflow three years ago

B. an initial investment today.
C. an annual cost over the life of the project.
D. a sunk cost.
Q.4. You are considering a new project that will require an initial build-up of raw materials inventory.
The expected life of the project's equipment is seven years. If all goes as you expect, you will replace
the equipment at the end of the seven years. If not, you will terminate the project. You currently
believe there is a fifty-fifty chance of either occurrence. How should you treat the raw material
inventory in year seven of your present analysis and why?
A. treat half of it as a cash inflow because there is a 50 percent chance the project will
terminate then
B. treat it as a cash outflow because it is expected that the machines will be replaced
C. treat it as a cash inflow because the replacement of the machines becomes a new capital
budgeting decision at that point
D. treat half as a cash inflow in year seven, but also treat only half as a cash outflow at the
beginning of the project
Q.5. Suppose you purchase a machine for Rs. 14,000. The cost is depreciated straight-line to a
salvage value of zero over its 4-year life. If the machine is sold at the end of the third year for Rs.
6,000, what are the after-tax proceeds from the sale assuming the tax rate is 34 percent?
A. Rs. 5,150
B. Rs. 6,990
C. Rs. 3,960
D. Rs. 5,010
Q.6. Mr. Rao is considering automating his Glass factory with the purchase of a machine worth Rs.
475,000. Shipping and installation would cost Rs. 5,000. Ahmad has calculated that automation
would result in savings of Rs. 45,000 a year due to reduced scrap and Rs. 65,000 a year due to
reduced labor costs. The machine has a useful life of 4 years and falls in the 3-year property class for
depreciation purposes. The estimated final salvage value of the machine is Rs. 120,000. The firm's
marginal tax rate is 34 percent. The incremental cash outflow at time period 0 is closest to:
A. Rs. 480,000
B. Rs. 580,000
C. Rs. 380,000
D. Rs. 280,000
Q.7. All incidental effects of a project on the rest of the firm should be considered while estimating
project cash flows because:
A. It may have a complementary relationship with the existing activities

B. It may have a competitive relationship with the existing activities
C. Both A and B
D. None of the above
Q.8. You are considering investing in a cost cutting proposal. Net income from the project is
expected to equal Rs. 27.50 each of the three years of the project's life. The process has an initial
cost of Rs. 125 and will be depreciated straight-line over 3 years to a salvage value of Rs. 0. Assume a
34 percent tax bracket and a discount rate of 15 percent. What is the value of the tax shield in each
period from the investment in the process?
A. Rs. 8.50
B. Rs. 14.17
C. Rs. 27.50
D. Rs. 41.67
Q.9. Motorhead Ironworks Inc. is contemplating the purchase of a more advanced extrusion
machine to replace the machine currently being used in its production process. The firm’s
production engineers contend that the newer machine will turn out the current volume of output
more efficiently. They note the following facts in support of their contention:
 The old machine can be used for four more years. It has a current salvage value of Rs. 8,000,
but if held to the end of its useful life, the old machine would have an estimated final
salvage value of Rs. 2,000. This is the final year that tax depreciation will be taken on the
machine, and the amount of depreciation is equal to the machine’s remaining depreciated
(tax) book value of Rs. 4,520.
 The new, advanced extrusion machine costs $60,000. Its final salvage value is projected to
be Rs. 15,000 at the end of its four-year useful life. It will be depreciated annually at a rate 0f
25 percent as per the written down value method.
 The new machine will reduce labor and maintenance usage by Rs. 12,000 annually.
 Income taxes on incremental profits are paid at a 40 percent rate.
What is the expected annual incremental cash flow for the final year?
A. Rs. 11,392
B. Rs. 11,700
C. Rs. 9731.25
D. Rs. 17,531.25
Q.10. In the above question, what is the estimated initial cash outflow?
A. Rs. 53,392
B. Rs. 53, 293
C. Rs. 53, 923
D. None of the above
Q.11. A taxable gain occurs when an asset is sold for more than its book value. For capital budgeting
purposes, the taxes on the sale are treated as a:
A. reduction in cash and added to operating cash flow.

B. noncash event similar to depreciation.
C. reduction in cash and deducted from the book value of the asset.
D. reduction in cash and deducted from the sale price.
Q.12. Which one of the following is least likely to cause erosion?
A. You begin selling coffee in new, smaller-sized foil pouches alongside your regular sizes of
coffee cans.
B. A gas station owner expands his building to make room for a convenience store.
C. You build a Burger King just down the street from your McDonalds.
D. Your grocery store begins to carry additional flavours of ice cream.
ANSWERS
Q.1 Q.2 Q.3 Q.4 Q.5 Q.6 Q.7 Q.8 Q.9 Q.10 Q.11 Q.12
A C D C A A C B D A D B

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Q.1.

Product cannibalisation involves:

A. Erosion of sales of an existing product due to own new product

A. sunk costs exist.

A. a cash outflow three years ago

A. It may have a complementary relationship with the existing activities

A. reduction in cash and added to operating cash flow.

Q.12. Which one of the following is least likely to cause erosion?

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