FIN 3113
Compute the NPV statistic for Project X given the following cash flows if the appropriate cost of capital is 10 percent. Project X Time 0 1 2 3 4 Cash Flow -$ 100,000 -$ 36,000 $ 200,000 $ 210,000 -$ 10,000
$183,507.96
You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $210,000. The truck falls into the MACRS 10-year class, and it will be sold after 10 years for $21,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,100. The truck will have no effect on revenues, but it is expected to save the firm $88,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 30 percent. What will the cash flows for this project be during year 2?
+Fixed costs save 88,000 −Depreciation -37,800 =EBIT 50,200 −Taxes -15,060 =Net Income 35,140 +Depreciation 37,800 OCF/TCF 72,940
Compute the IRR for Project F. The appropriate cost of capital is 13 percent. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Project F Time: 0 1 2 3 4 Cash flow: -$11,700 $4,200 $5,030 $2,370 $3,000
0 + (-$11,700/(1+IRR)^0) + ($4,200/(1+IRR)^1) + ($5,030/(1+IRR)^2) + ($2,370/(1+IRR)^3) + ($3,000/(1+IRR)^4) IRR = 10.45% Since IRR < i, this project should be rejected.
Compute the IRR static for Project E. The appropriate cost of capital is 9 percent. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Project E Time: 0 1 2 3 4 5 Cash flow -$3,300 $1,030 $990 $860 $640 $440
0 = (-$3,300/(1+IRR)^0) + ($1,030/(1+IRR)^1) + ($990/(1+IRR)^2) + ($860/(1+IRR)^3) + ($640/(1+IRR)^4) + ($440/(1+IRR)^5) IRR = 7.41% Since IRR < i, this project should be rejected.
Equipment was purchased for $100,000 plus $1,000 in freight charges. Installation costs were $500 and sales tax totaled $7,500. Hiring a special consultant to provide advice during the selection of the equipment cost $1,000. What is this asset's depreciable basis?
100,000 + 1,000 + 500 + 7,500 = 109,000
Equipment was purchased for $250,000 plus $500 in freight charges. Installation costs were $750 and sales tax totaled $18,750. Hiring a special consultant to provide advice during the selection of the equipment cost $500. What is this asset's depreciable basis?
250,000 + 500 + 750 + 18,750 = 270,000
Suppose you sell a fixed asset for $10,000 when its book value is $2,000. If your company's marginal tax rate is 35 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?
AT CF = $10,000 − ($10,000 − $2,000) × 0.35 = $7,200
Suppose you sell a fixed asset for $117,000 when it's book value is $139,000. If your company's marginal tax rate is 33 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)
AT CF = $139,000 + ($117,000 − $139,000) x (1 − .33) = $124,260
Suppose you sell a fixed asset for $81,000 when it's book value is $92,000. If your company's marginal tax rate is 35 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)?
AT CF = $92,000 + ($81,000 − $92,000) x (1 − .35) = $84,850
Suppose you sell a fixed asset for $119,000 when its book value is $139,000. If your company's marginal tax rate is 35 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? (Enter your answer as a whole number.)
ATCF = Book value + (Market value - Book value) × (1 - TC ) = $139,000 + ($119,000 - $139,000) × (1 - 0.35) = $126,000
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 9 percent, and that the maximum allowable payback and discounted payback statistics for the project are 2.5 and 3.5 years, respectively. Time: 0 1 2 3 4 5 6 Cash flow: -$4,600 $1,160 $2,360 $1,560 $1,560 $1,360 $1,160
Cumulative cash flow will switch from negative to positive between years 2 and 3: Year 0 1 2 3 4 Cash flow: -$ 4,600 $ 1,160 $ 2,360 $ 1,560 $ 1,560 5 6 $1,360 $ 1,160 Cumulative cash flow: -$ 4,600 -$ 3,440 -$ 1,080 480 Specifically, PB = 2 + $1,080/$1,560 = 2.69 years, which is more than the maximum allowable payback, so this project should be rejected.
When calculating operating cash flow for a project, one would calculate it as being mathematically equal to which of the following?
EBIT - Taxes + Depreciation
Which of the following measures the operating cash flow a project produces minus the necessary investment in operating capital, and is as valid for proposed new projects as it is for the firm's current operations?
Free cash flow
Which of these is used as a measure of the total amount of available cash flow from a project?
Free cash flow
Which of these describe groups or pairs of projects where you can accept one but not all?
Mutually exclusive
Compute the PI statistic for Project Q if the appropriate cost of capital is 12 percent. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Project Q Time: 0 1 2 3 4 Cash flow: -$11,600 $3,650 $4,480 $1,820 $2,450
NPV = -$11,600 + ($3,650/(1.12)^1) + ($4,480/(1.12)^2) + ($1,820/(1.12)^3) + ($2,450/(1.12)^4) = $-1,917.18 PI = (-$1,917.18 + $11,600)/$11,600 = 0.83 Since PI < 1, this project should be rejected.
Compute the NPV statistic for Project U if the appropriate cost of capital is 11 percent. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places.) Project U Time: 0 1 2 3 4 5 Cash flow: -$2,500 $750 $2,480 -$720 $700 -$300
NPV = -$2,500 + ($750/(1.11)^1) + ($2,480/(1.11)^2) + (-$720/(1.11)^3) + ($700/(1.11)^4) + (-$300/(1.11)^5) = -$54.88
Compute the PI statistic for Project Z if the appropriate cost of capital is 6 percent. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Project Z Time: 0 1 2 3 4 5 Cash flow: -$3,200 $710 $840 $1,010 $660 $460
NPV = -$3,200 + ($710/(1.06)^1) + ($840/(1.06)^2) + ($1,010/(1.06)^3) + ($660/(1.06)^4) + ($460/(1.06)^5) = $-68.06 PI = (-$68.06 + $3,200)/$3,200 = 0.98 Since PI < 1, the project should be rejected.
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 13 percent, and that the maximum allowable payback and discounted payback statistics for your company are 2.5 and 3.0 years, respectively. Time: 0 1 2 3 4 5 Cash flow: -$364,000 $64,900 $83,100 $140,100 $121,100 $80,300
NPV = -$364,000 + ($64,900/(1.13)^1) + ($83,100/(1.13)^2) + ($140,100/(1.13)^3) + ($121,100/(1.13)^4) + ($80,300/(1.13)^5) = −$26,534.03 Since NPV < 0, the project should be rejected.
Compute the NPV statistic for Project Y if the appropriate cost of capital is 10 percent. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places.) Project Y Time: 0 1 2 3 4 Cash flow: -$8,500 $3,730 $4,560 $1,900 $680
NPV = -$8,500 + ($3,730/(1.10)^1) + ($4,560/(1.10)^2) + ($1,900/(1.10)^3) + ($680/(1.10)^4) = $551.45 Accepted
Compute the NPV for Project M if the appropriate cost of capital is 8 percent. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places.) Project M Time: 0 1 2 3 4 5 Cash flow: -$2,200 $590 $720 $760 $840 $340
NPV = −$2,200 + ($590/(1.08)^1) + ($720/(1.08)^2) + ($760/(1.08)^3) + ($840/(1.08)^4) + ($340/(1.08)^5) = $415.72 Accepted
Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects?
Net present value
Which of these are sets of cash flows where all the initial cash flows are negative and all the subsequent ones are either zero or positive?
Normal cash flows
You are evaluating a project for The Tiff-any golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $470 per unit and sales volume to be 1,200 units in year 1; 1,125 units in year 2; and 1,000 units in year 3. The project has a 3-year life. Variable costs amount to $260 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $144,000 in assets, which will be depreciated straight-line to zero over the 3-year project life. The actual market value of these assets at the end of year 3 is expected to be $28,000. NWC requirements at the beginning of each year will be approximately 30 percent of the projected sales during the coming year. The tax rate is 30 percent and the required return on the project is 12 percent. What is the operating cash flow for the project in year 2? (Enter your answer as a whole number.)
Sales $ 528,750 - Variable costs 292,500 - Fixed costs 100,000 - Depreciation 48,000 EBIT $ 88,250 - Taxes 26,475 "Net income" $ 61,775 + Depreciation 48,000 OCF $ 109,775
You are evaluating a project for your company. You estimate the sales price to be $330 per unit and sales volume to be 4,300 units in year 1; 5,300 units in year 2; and 3,800 units in year 3. The project has a three-year life. Variable costs amount to $180 per unit and fixed costs are $215,000 per year. The project requires an initial investment of $240,000 in assets which will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $43,000. NWC requirements at the beginning of each year will be approximately 13 percent of the projected sales during the coming year. The tax rate is 35 percent and the required return on the project is 9 percent. What is the operating cash flow for the project in year 2?
Sales 1,749,000 -Variable Costs 954,000 −Fixed Costs -215,000 −Depreciation -80,000 =EBIT 500,000 −Taxes -175,000 =Net Income 325,000 +Depreciation 80,000 =OCF 405,000
Your company has spent $270,000 on research to develop a new computer game. The firm is planning to spend $47,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $5,700. The machine has an expected life of 10 years, a $32,000 estimated resale value, and falls under the MACRS 15-Year class life. Revenue from the new game is expected to be $370,000 per year, with costs of $170,000 per year. The firm has a tax rate of 30 percent, an opportunity cost of capital of 12 percent, and it expects net working capital to increase by $57,000 at the beginning of the project. What will be the net cash flow for year one of this project?
Sales 370,000 -Fixed costs -170,000 -Depreciation -2,635 =EBIT 197,365 - Taxes -59,210 = Net Income 138,155 + Depreciation 2,635 OCF 140,790
If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a:
Sunk cost
Your firm needs a computerized machine tool lathe which costs $53,000 and requires $12,300 in maintenance for each year of its 3-year life. After three years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 34 percent and a discount rate of 12 percent. If the lathe can be sold for $5,300 at the end of year 3, what is the after-tax salvage value? (Round your answer to 2 decimal places.)
The lathe will have a remaining book value of 7.41% × $53,000 = $3,927.30. The after-tax cash flows from the sale of the lathe will be: ATCF = Book value + (Market value - Book value) × (1 - TC ) = $3,927.30 + ($5,300 - $3,927.30) × (1 - 0.34) = $4,833.28
Your firm needs a machine which costs $50,000, and requires $2,000 in maintenance for each year of its five-year life. After five years, this machine will be replaced. The machine falls into the MACRS five-year class life category. Assume a tax rate of 35 percent and a discount rate of 10 percent. If this machine can be sold for $3,000 at the end of year 5, what is the after-tax salvage value?
The machine will have a remaining book value of 5.76 percent × $50,000 = $2,880. Using equation 12−3, the after-tax cash flows from the sale of the machine will be: $2,880 + ($3,000 − $2,880) × (1 − 0.35) = $2,958
Compute the payback statistic for Project A if the appropriate cost of capital is 7 percent and the maximum allowable payback period is four years. (Round your answer to 2 decimal places.) Project A Time: 0 1 2 3 4 5 Cash flow: -$1,700 $630 $690 $660 $440 $240
Year 0 1 2 3 4 5 Cash flow: -$ 1,700 $ 630 $ 690 $ 660 $ 440 $ 240 Cumulative cash flow: -$ 1,700 -$ 1,070 -$ 380 $ 280 This project will achieve payback at time 2 + $380/$660 = 2.58 years.
Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 11 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time: 0 1 2 3 Project A Cash Flow -38,000 28,000 48,000 19,000 Project B Cash Flow -48,000 28,000 38,000 68,000 Use the PI decision rule to evaluate these projects; accept the project with the higher PI value.
reject A, accept B
Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time: 0 1 2 3 Project A Cash Flow -30,000 20,000 40,000 11,000 Project B Cash Flow -40,000 20,000 30,000 60,000 Use the NPV decision rule to evaluate these projects; which one(s) should it be accepted or rejected?
reject A, accept B
With regard to depreciation, the time value of money concept tells us that:
taking the depreciation expense sooner is always better.
We accept projects with a positive NPV because it means that:
we have recovered all our costs. we are creating wealth for shareholders. the project's expected return exceeds the cost of capital. all of the options.
