SUNK COSTS



FIN350 exercise on Capital Budgeting and Relevant Cash Flows

1. For a project with an initial investment of $8,000 and cash inflows of $2,000 each year for 6 years, calculate NPV given a required return of 13%.

A) –$846

B) –$263

C) –$4.9

D) $149

E) $552

2. What is the payback period for the following investment?

[pic]

2 .5 years

3. A cost that has already been paid, or the liability to pay has already been incurred, is a(n):

a. Salvage value expense.

b. Net working capital expense.

c. Sunk cost.

d. Opportunity cost.

4. The most valuable investment given up if an alternative investment is chosen is a(n):

a. Salvage value expense.

b. Sunk cost.

c. Opportunity cost.

d. Erosion cost.

5. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept? (The projects have the same risk as the firm’s existing assets. Also assume these projects are normal projects. )

a. Project A requires an up-front expenditure of $3,000,000 and generates a net present value of $3,200.

b. Project B has an internal rate of return of 9.5 percent.

c. Project C requires an up-front expenditure of $5,000,000 and generates a positive internal rate of return of 9.7 percent.

d. Project D has an internal rate of return of 9 % and generates a net present value of

- $6, 000.

e. None of the projects above should be accepted.

6. Marshall’s & Co. purchased a corner lot in Eglon City five years ago at a cost of $640,000. The lot was recently appraised at $810,000. At the time of the purchase, the company spent $50,000 to grade the lot and another $4,000 to build a small building on the lot to house a parking lot attendant who has overseen the use of the lot for daily commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.2 million. What amount should be used as the initial cash flow for this building project?

a. $1,200,000

b. $1,840,000

c. $1,890,000

d. $2,010,000

e. $2,060,000

7. Wilbert’s, Inc. paid $90,000, in cash, for a piece of equipment three years ago. Last year, the company spent $10,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $50,000 from a firm who would like to purchase it. Wilbert’s is debating whether to sell the equipment or to expand its operations such that the equipment can be used. When evaluating the expansion option, what value, if any, should Wilbert’s assign to this equipment as an initial cost of the project?

a. $40,000

b. $50,000

c. $60,000

d. $80,000

e. $90,000

8. ABC Plastics currently produces plastic plates. The company is considering expanding their production to include plastic silverware. Payment for which of the following are relevant to this project?

I. the plastic used to make the silverware

II. the labor involved in making the silverware

III. the mortgage on the existing building used for production

IV. the plastic needed to produce the additional plates they expect to sell if they expand their product offerings 

 a. I and II only

b. III and IV only

c. I, II, and IV only

d. I, II, and III only

e. I, II, III, and IV

I,II, and III are relevant cost; will incur III regard less of whether to expand the production.

9. The firm of Mitchell and Mitchell owns a small truck. The truck has a market value of $9,500 today. New, it cost $24,900. Last week, the company spent $3,500 repairing the engine and replacing the brake pads. The company still owes $1,200 in truck payments. If the company decides to use this vehicle for a new project, the cost assigned to that project for this truck should be: 

 a. $8,300.

b. $9,500.

c. $11,800.

d. $13,000.

e. $14,200.

1. For a project with an initial investment of $8,000 and cash inflows of $2,000 each year for 6 years, calculate NPV given a required return of 13%.

A) –$846

B) –$263

C) –$4.9

D) $149

E) $552

2. What is the payback period for the following investment?

[pic]

2 .5 years

3. A cost that has already been paid, or the liability to pay has already been incurred, is a(n):

a. Salvage value expense.

b. Net working capital expense.

c. Sunk cost.

d. Opportunity cost.

4. The most valuable investment given up if an alternative investment is chosen is a(n):

a. Salvage value expense.

b. Sunk cost.

c. Opportunity cost.

d. Erosion cost.

5. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept? (The projects have the same risk as the firm’s existing assets. Also assume these projects are normal projects. )

a. Project A requires an up-front expenditure of $3,000,000 and generates a net present value of $3,200.

b. Project B has an internal rate of return of 9.5 percent.

c. Project C requires an up-front expenditure of $5,000,000 and generates a positive internal rate of return of 9.7 percent.

d. Project D has an internal rate of return of 9 % and generates a net present value of

- $6, 000.

e. None of the projects above should be accepted.

6. Marshall’s & Co. purchased a corner lot in Eglon City five years ago at a cost of $640,000. The lot was recently appraised at $810,000. At the time of the purchase, the company spent $50,000 to grade the lot and another $4,000 to build a small building on the lot to house a parking lot attendant who has overseen the use of the lot for daily commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.2 million. What amount should be used as the initial cash flow for this building project?

a. $1,200,000

b. $1,840,000

c. $1,890,000

d. $2,010,000

e. $2,060,000

7. Wilbert’s, Inc. paid $90,000, in cash, for a piece of equipment three years ago. Last year, the company spent $10,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $50,000 from a firm who would like to purchase it. Wilbert’s is debating whether to sell the equipment or to expand its operations such that the equipment can be used. When evaluating the expansion option, what value, if any, should Wilbert’s assign to this equipment as an initial cost of the project?

a. $40,000

b. $50,000

c. $60,000

d. $80,000

e. $90,000

8. ABC Plastics currently produces plastic plates. The company is considering expanding their production to include plastic silverware. Payment for which of the following are relevant to this project?

I. the plastic used to make the silverware

II. the labor involved in making the silverware

III. the mortgage on the existing building used for production

IV. the plastic needed to produce the additional plates they expect to sell if they expand their product offerings 

 a. I and II only

b. III and IV only

c. I, II, and IV only

d. I, II, and III only

e. I, II, III, and IV

I,II, and III are relevant cost; will incur III regard less of whether to expand the production.

9. The firm of Mitchell and Mitchell owns a small truck. The truck has a market value of $9,500 today. New, it cost $24,900. Last week, the company spent $3,500 repairing the engine and replacing the brake pads. The company still owes $1,200 in truck payments. If the company decides to use this vehicle for a new project, the cost assigned to that project for this truck should be: 

 a. $8,300.

b. $9,500.

c. $11,800.

d. $13,000.

e. $14,200.

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