Discussion 5.5


Field Trip


In this Web Field Trip you will visit the following websites that offer information regarding market crisis.



    In addition, conduct additional research to learn more about this topic and be sure to cite your sources.

    The questions below are based on your Web Field Trip.

    Which of these crises was the worst in terms of stock market loss and duration? What do you think caused the crisis you selected to be the worst? (In your response, compare and contrast the three crises as best you can with the limited information and any other sources you have.)



What effect does the author of “Stock Market Unrelenting Bullishness Amidst Deteriorating Economic Conditions” say the current recession will have on our children? What do you think the legacy of the current economic situation will be?


Healthy Potions, Inc., a pharmaceutical company, bought a machine that produces pain-reliever medicine at a cost of $2 million five years ago. The machine has been depreciated over the past five years, and the current book value is $900,000. The company decides to sell the machine now at its market price of $1 million. The marginal tax rate is 34 percent.


What are the relevant cash flows? $_______________


How do the change if the market price of the machine is $600.000 instead?


Change in cash flow $____________


Healthy Potions, Inc., is considering investing in a new production line for eye drops. Other than investing in the equipment, the company needs to increase its cash and cash equivalents by $10,000, increase the level of inventory by $28,436, increase accounts receivable by $25,000, and increase accounts payable by $5,000 at the beginning of the project. Healthy Potions will recover these changes in working capital at the end of the project 12 years later. Assume the appropriate discount rate is 11.5 percent. What are the present values of the relevant investment cash flows? (Round answer to 2 decimal places, e.g. 15.25.)


Present value $______________


You are thinking about delivering pizzas in your spare time. Since you must use your own car to deliver the pizzas, you will wear out your current car one year earlier, which is one year from today, than if you did not take on the delivery job. You estimate that when you purchase a new car, regardless of when that occurs, you will pay $22,000 for the car and it will last you five years. If your opportunity cost of capital is 6.8 percent, what is the opportunity cost of using your car to deliver pizzas? (Round answer to 2 decimal places, e.g. 15.25.)


Opportunity cost $____________


Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 88 percent as high if the price is raised 14 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year? (Round answers to nearest whole dollar, e.g. 5,275.)


At $20 per bottle the Chips FCF is $_____________ and at the new price Chip’s FCF is $______________


Suppose that you could invest in the following projects but have only $30,200 to invest. How would you make your decision and which projects would you invest in, using Profitability index?


Project Cost NPV
A $ 7,900 $ 3,871
B 10,900 7,194
C 8,800 4,664
D 7,400 3,996


You should invest in projects


B and C only


A, B, and C


B, C, and D


A and B only


B and D only


Mick’s Soft Lemonade is starting to develop a new product for which the cash fixed costs are expected to be $115,000. The projected EBIT is $128,000, and the Accounting DOL is expected to be 2.3. What is the Cash Flow DOL for the firm? (Round answer to 2 decimal places, e.g. 15.25.)


The Cash Flow DOL for the firm is ______________


A project’s salvage value is likely to be ignored in the


[removed] depreciation expense technique




[removed] internal rate of return technique




[removed] payback period technique




[removed] net present value technique


Cash flows over a project’s life should include


[removed] depreciation expense




[removed] dividends paid




[removed] sunk costs




[removed] interest paid


When discounting cash flows,


[removed] discount nominal cash flows using the cost of debt




[removed] discount real cash flows using a nominal rate of return




[removed] discount nominal cash flows using a nominal rate of return




[removed] discount real cash flows using the cost of equity


Amsted, Inc. is considering a project that will increase revenues by $2.5 million, cash operating expenses by $700,000, and depreciation and amortization by $300,000 during 2011. For this project, the firm will purchase $800,000 of equipment during the year while decreasing its inventory by $200,000 (with no corresponding decrease in current liabilities). The marginal tax rate for Amsted is 35 percent. What is this project’s incremental after-tax free cash flow for 2011?


[removed] $275,000




[removed] $975,000




[removed] $675,000




[removed] $475,000


Which of the following is not an example of a variable cost?


[removed] depreciation




[removed] product packaging




[removed] shipping and handling expenses




[removed] direct labor


Which of the following can influence a firm’s operating profit?


[removed] the number of common shares outstanding




[removed] the firm’s debt-equity ratio




[removed] the amount of dividends a firm pays its shareholders




[removed] the extent to which a firm uses fixed operating costs


Which costs should be excluded when calculating the Accounting Degree of Operating Leverage?


[removed] real estate taxes




[removed] depreciation




[removed] administrative expenses




[removed] none of these


The amount of fixed costs that a firm incurs and the fluctuations in its cash flows and profits are


[removed] inversely related.




[removed] unrelated.




[removed] directly related.




[removed] exponentially related.


The degree of a firm’s Pre-tax Cash Flow Operating Leverage is a measure of the sensitivity of its cash flow from operations (EBITDA) to changes in.


[removed] its capital invested.




[removed] its revenues.




[removed] its earnings.




[removed] its cash flows.


In order to calculate a firm’s EBITDA break-even point, we must divide its fixed costs by its


[removed] sales.




[removed] total costs.




[removed] net profits.




[removed] per unit contribution.








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