Quiz 2a

1) Marshall's purchased a corner lot five years ago at a cost of $498,000 and then spent
$63,500 on grading and drainage so the lot could be used for storing outdoor inventory. The
lot was recently appraised at $610,000. The company now wants to build a new retail store on
the site. The building cost is estimated at $1.1 million. What amount should be used as the
initial cash outflow for this building project?
A) $1,661,500
B) $1,100,000
C) $1,208,635
D) $1,710,000
E) $1,498,000

Answer – D, Explanation: CF0 = $610,000 + 1,100,000

2) The Boat Works currently produces boat sails and is considering expanding its operations
to include awnings. The expansion would require the use of land the firm purchased three
years ago at a cost of $197,000 that is currently valued at $209,500. The expansion could use
some equipment that is currently sitting idle if $7,500 of modifications were made to it. The
equipment originally cost $387,500 five years ago, has a current book value of $132,700, and
a current market value of $139,000. Other capital purchases costing $520,000 will also be
required. What is the value of the opportunity costs that should be included in the initial cash
outflow for the expansion project?
A) $425,000
B) $485,000
C) $329,700
D) $348,500
E) $537,200

Answer – D, Explanation: Opportunity cost = $209,500 + 139,000, Opportunity cost =

$348,500

3) Walks Softly currently sells 14,800 pairs of shoes annually at an average price of $59 a
pair. It is considering adding a lower-priced line of shoes that will be priced at $39 a pair. The
company estimates it can sell 6,000 pairs of the lower-priced shoes annually but will sell
3,500 less pairs of the higher-priced shoes each year by doing so. What annual sales revenue
should be used when evaluating the addition of the lower-priced shoes?
A) $27,500
B) $24,000
C) $31,300
D) $789,100
E) $900,700

Answer – A, Explanation: Sales = 6,000($39) − 3,500($59), Sales = $27,500

4) Sue purchased a house for $89,000, spent $56,000 upgrading it, and currently had it
appraised at $212,900. The house is being rented to a family for $1,200 a month, the
maintenance expenses average $200 a month, and the property taxes are $4,800 a year. If she
sells the house she will incur $20,000 in expenses. She is considering converting the house
into professional office space. What opportunity cost, if any, should she assign to this
property if she has been renting it for the past two years?
A) $178,500
B) $120,000
C) $185,000
D) $192,900
E) $232,900

Answer: D, Explanation: Opportunity cost = $212,900 − 20,000, Opportunity cost =

$192,900

5) If Lew's Steel Forms purchases $618,000 of new equipment, they can lower annual
operating costs by $265,000. The equipment will be depreciated straight-line to a zero book
value over its 3-year life. Ignore bonus depreciation. At the end of the three years, the
equipment will be sold for an estimated $60,000. The equipment will require the company to
hold an extra $23,000 of inventory over the 3-year period. What is the NPV if the discount
rate is 14 percent and the tax rate is 21 percent?
A) −$2,646.00
B) −$7,014.54
C) −$12,593.78
D) $3,106.54
E) $6,884.40

Answer: B
Explanation: CF0 = −$618,000 − 23,000
CF0 = −$641,000
OCF = [$0 − (−$265,000)](1 − .21) + ($618,000/3)(.21)
OCF = $252,610
Aftertax salvage value = $60,000 − ($60,000 − 0)(.21)
Aftertax salvage value = $47,400
NPV = −$641,000 + $252,610[(1 - 1/1.143)/.14] + ($47,400 + 23,000)/1.143
NPV = −$7,014.54