quiz 10

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $187,600 a year. The project will require new equipment costing $580,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of$169,000 at the end of the project. The project requires an initial investment of $39,000 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

0 = −$580,000 − 39,000 + $187,600(PVIFAIRR,5) + [$39,000 + (1 − .35)($169,000)]/(1 + IRR)^5 IRR = 20.13%

Power Manufacturing has equipment that it purchased 7 years ago for $2,750,000. The equipment was used for a project that was intended to last for 9 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $440,000 today. The company's tax rate is 34 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,750,000/9= $305,556 Book value = $2,750,000 − 7($305,556) = $611,111 Tax refund (due) = ($611,111 − 440,000)(.34)= $58,178 Aftertax salvage value = $440,000 + 58,178 = $498,178

A 4-year project has an annual operating cash flow of $56,000. At the beginning of the project, $4,700 in net working capital was required, which will be recovered at the end of the project. The firm also spent $23,300 on equipment to start the project. This equipment will have a book value of $5,020 at the end of the project, but can be sold for $5,940. The tax rate is 34 percent. What is the Year 4 cash flow?

Cash flow = $56,000 + 4,700 + 5,940 + .34($5,020 − 5,940) Cash flow = $66,327

The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $377,000 and expenses by $264,000. The project will require $173,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 40 percent. What is the depreciation tax shield (annually)?

Depreciation tax shield = .40($173,000/6) Depreciation tax shield = $11,533

A project is expected to generate annual revenues of $118,500, with variable costs of $75,100, and fixed costs of $15,600. The annual depreciation is $3,900 and the tax rate is 40 percent. What is the annual operating cash flow?

OCF = ($118,500 − 75,100 − 15,600)(1 − .40) + .40($3,900) = $18,240

A project has annual depreciation of $24,700, costs of $100,700, and sales of $148,500. The applicable tax rate is 35 percent. What is the operating cash flow?

OCF = ($148,500 − 100,700)(1 − .35) + .35($24,700) OCF = $39,715

Rock Haven has a proposed project that will generate sales of 1,845 units annually at a selling price of $31 each. The fixed costs are $17,400 and the variable costs per unit are $9.55. The project requires $33,400 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $8,700 and the tax rate is 34 percent. What is the operating cash flow?

OCF = [1,845($31 − 9.55) − $17,400](1 − .34) + .34($33,400/4) OCF = $17,475

You own a house that you rent for $1,325 per month. The maintenance expenses on the house average $245 per month. The house cost $228,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $250,000. If you sell the house you will incur $20,000 in real estate fees. The annual property taxes are $2,950. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $250,000 − 20,000 Opportunity cost = $230,000

Gateway Communications is considering a project with an initial fixed assets cost of $1.69 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $227,000. The project will not change sales but will reduce operating costs by $381,000 per year. The tax rate is 40 percent and the required return is 10.2 percent. The project will require $45,500 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,690,000 − 45,500= −$1,735,500 OCF = $381,000(1 − .40) + .40($1,690,000/10) = $296,200 Year 10 CF (w/o OCF) = $45,500 + 227,000(1 − .40)= $181,700 NPV = −$1,735,500 + 296,200(PVIFA10.2%,10) + 181,700/1.10210 NPV = $137,780

Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $58,000 per year for 7 years. At the beginning of the project, inventory will decrease by $18,400, accounts receivables will increase by $22,200, and accounts payable will increase by $15,900. At the end of the project, net working capital will return to thelevel it was prior to undertaking the new project. The initial cost of the molding machine is $258,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating an aftertax cash flow of $54,000. What is the net present value of this project given a required return of 10.3 percent?

Year 0 CF = −$258,000 + 18,400 − 22,200 + 15,900= −$245,900 Year 7 CF (w/o OCF) = $54,000 − 18,400 + 22,200 − 15,900= $41,900 NPV = −$245,900 + 58,000(PVIFA10.3%,7) + 41,900/1.1037 NPV = $54,796